A borrower misses a payment. Take me through what your systems do from that morning through to the loan being written off.

Before it is a credit event, test whether it is your fault

The first branch on the morning after a missed instalment is unglamorous and it is the one that saves the most money and the most complaints. A payment can be absent because the borrower has no money, and it can be absent because your own path failed: a direct debit presented against a closed mandate, a collection attempted on a non-working day, a payment received and posted to a suspense account because the reference did not match, a payment applied to the wrong account, a rescheduled due date that did not propagate to the collection file. All of those look identical in the arrears counter.

So the account enters a short holding state where the payment is chased and the posting is checked before any external consequence fires. This matters because the consequences that follow are hard to unwind: once you have sent a notice of arrears, reported a missed payment to a credit reference agency and started charging, undoing it requires a correction to every one of those destinations, and the credit-file correction is the one the customer will remember. Building a first bucket that is internal-only is a design decision with a clear rationale rather than leniency.

Three tracks, moving at different speeds

The reason this question separates candidates is that a delinquent account is simultaneously in three states, and people who have only seen one of them describe the whole thing as a queue.

The collections state is operational. It is usually expressed in buckets by days past due, and it drives contact strategy, who owns the case, what tone the correspondence takes, whether the account is with an internal team or an external agency, and when formal notices are issued. Its granularity is days.

The impairment state is accounting. Under the expected credit loss model, an exposure sits in one of three stages: performing, with a loss allowance measured over the coming twelve months; significantly deteriorated, where the allowance becomes a lifetime measure; and credit-impaired, where it is lifetime and interest revenue recognition changes. The trigger for the middle stage is a significant increase in credit risk since origination, which is a forward-looking judgement about probability of default rather than a fact about days past due — the standard treats thirty days past due as a rebuttable presumption of that increase, not as its definition. So an exposure can move stage on a model output, a watchlist flag or a sector deterioration while every instalment has been paid on time. That is the single most commonly missed point in this question.

The reported state is external. Arrears markers, defaults and subsequent satisfaction are reported to credit reference agencies on their own cadence and with their own definitions, and once a default is registered it persists on the borrower's file for a defined period regardless of what happens afterwards. Because it is visible to the borrower and to every other lender, its accuracy is a consumer-protection matter in its own right.

stateDiagram-v2
  [*] --> Performing
  Performing --> Arrears
  Arrears --> Forborne
  Arrears --> Defaulted
  Forborne --> Performing
  Forborne --> Defaulted
  Defaulted --> WrittenOff
  WrittenOff --> Recovered

The transitions worth arguing about are the two that go backwards: what evidence lets a forborne account be called performing again, and the fact that a written-off exposure can still produce cash.

Forbearance changes the contract, not just the diary

When a borrower is in difficulty the right answer is frequently a concession: a payment holiday, a reduced instalment, a term extension, capitalising the arrears, or converting to interest-only for a period. Each of these is a modification of the credit agreement and has to be documented and consented to, not applied as an operational adjustment. Each also changes what the borrower will pay in total, usually upwards, which is the fact that must be disclosed rather than buried.

The reason forbearance is where supervisors look hardest is that it repairs the wrong number. Grant a payment holiday and the days-past-due counter goes to zero, the collections bucket empties, and the arrears management report looks better while the borrower's actual capacity to repay has not changed at all. That is why forborne exposures are flagged and tracked as their own population, why they are not simply returned to performing because the counter reset, and why coming out of forbearance normally requires a period of demonstrated payment before the exposure is treated as cured. A system that models forbearance by editing the schedule and clearing the counter has destroyed the evidence that a supervisor, and your own credit committee, need.

Default, write-off, and the debt that outlives both

These three are routinely conflated and an interviewer will pull on the distinction.

Default is a classification against a definition, generally taken when the borrower is unlikely to pay or a material obligation is more than ninety days past due, and it carries consequences across provisioning, capital and reporting. It is a judgement bounded by a backstop, not simply the arrival of a day count.

Write-off is an accounting recognition that you no longer have a reasonable expectation of recovering the exposure, so it leaves the balance sheet and the allowance is utilised. It does not extinguish the borrower's legal obligation, does not stop recovery activity, and does not mean the case is closed. Recoveries after write-off arrive as income, which is why a written-off account must remain addressable in your systems, with its history intact, for as long as the debt is legally enforceable.

That is the trap in the closing part of the question. Modelling write-off as a terminal state that archives the account, or as the point at which the customer relationship ends, breaks recovery accounting, breaks the audit trail from origination through to loss, and — if the account can no longer be corrected — breaks your ability to fix an error you find later. Keep the exposure, keep its whole timeline, and let the accounting treatment be an attribute of it rather than a reason to forget it.

Two obligations run right through this and are worth stating because candidates from a pure engineering background omit them. Consumer credit rules constrain what you may charge and how you must communicate at every stage; in the United Kingdom the Consumer Duty makes the outcome for the borrower, not merely the correctness of the process, the standard you are held to. And a borrower in difficulty may be vulnerable, which changes the appropriate contact strategy — so the vulnerability marker has to reach the collections path rather than sitting in a service note that the automated dialler never reads.

The counter going to zero is not the borrower recovering: keep collections state, impairment stage and reported history as three separate facts, and never let a concession quietly repair all three at once.