Borrowing money is a huge responsibility — you’re obligated to repay your loan according to the terms you agreed to with creditors.
“When taking out any loan, it’s important to research your loan agreement, including interest rates, monthly payments, and length of repayment,” said Katie Ross, the education and development manager for American Consumer Credit Counseling. “These details can help you calculate how much you can afford and thus help avoid loan default.”
But what does it mean to default on a loan? Default occurs when you don’t make your payments, but it doesn’t happen right away — a certain period of time must pass.
Defaulting on debt can lead to serious consequences, which vary based on the type of debt. Learn more about the dangers of defaulting on different loans, along with suggestions on what to do if you’re in danger of default.
What does it mean to default on a loan?
Every time you borrow money, you agree to make payments based on the lender’s terms. When you miss a scheduled payment, there’s a grace period sometimes before you’re considered late.
If you don’t make your payment by the time that grace period ends or by a scheduled deadline, you’re considered delinquent. If you continue to skip payments for a specified time, then your debt enters into default.
How long it takes for your debt to default depends on your lender and the type of loan. With federal student loans, for example, there’s a 270-day default timeline that’s set by law. For other types, your loan agreement specifies when you’ll go into default. Check your paperwork or contact your lender to find how much time you have before your debt is in danger of defaulting.
What happens if you default on a loan?
Whenever you default on a debt, lenders and collection agencies often try to collect the money, and the effort can happen for several years. The time lenders have to recoup their money varies by state. On federal student loans, however, lenders can try to collect forever.
Most lenders also report your default to credit reporting bureaus and your credit score will plummet, making it difficult to borrow money in the future. Defaults usually stay on your credit report for seven years, although you can begin rebuilding your credit immediately by making payments on time and using credit responsibly.
Other impacts of a default depend on the type of loan you have, the amount you owe, and how aggressive your lender is in its effort to recoup the money.
Here are the consequences you could face for defaulting on five types of loans.
1. Student loan debt
“When you go into student loan default, it can take years to recover financially,” said Ross. Defaulting on a student loan can result in:
- The full unpaid loan balance, plus interest, becoming due immediately
- Charges for attorney fees and collection costs
- Loss of eligibility for income-driven repayment plans, deferment, or forbearance
- A lawsuit by the student loan lender
- Wage garnishment, in which money is automatically taken out of your paycheck to repay the lender
- Seizure of your tax refund and loss of other federal benefits
- Your school withholding your transcript
- Your state revoking your professional license
- Private student loan lenders trying to collect from any cosigners
Student loans also can’t be discharged in bankruptcy in most cases, so you’ll be stuck dealing with this debt for life.
2. Personal loan debt
The repercussions of defaulting on a personal loan depend on whether it’s is secured or unsecured, according to Ross.
“Secured personal loans are backed by collateral. If you default on a [secured] personal loan, you risk losing the assets you used as collateral,” she explained. “If you default on an unsecured loan, the loan might be turned over to a collection agency.”
This means you could face:
- Loss of assets, such as a car or savings account, that serve as collateral for secured loans
- Lawsuits and charges for legal fees
- Wage garnishment, or money being taken from your paycheck after a court judgment
- Lien on a property after a court judgment, which gives the lender a legal claim on your property. When the property is sold, the lender receives a portion of the sale proceeds to satisfy the lien.
Your house acts as collateral for your mortgage, so it’s at risk if you default on the loan.
“Mortgage default can result in the lender filing for foreclosure in order to auction off the house for repayment of the debt,” Ross said. “Foreclosure proceedings take anywhere from one to two years.”
The impact of failing to pay your mortgage includes:
- Foreclosure proceedings in court
- The seizure and sale of your home
- A deficiency judgment. If your lender sells your home for an amount that’s less than what you owe, it could get a judgment against you for the balance. If that happens, you might be responsible for the remaining loan balance plus legal fees.
- Wage garnishment and liens on other properties if the lender gets a delinquency judgment
4. Car loan
Auto lenders are very strict when it comes to loan repayment, according to Ross. “Just a few missed payments and your car could be repossessed,” she said.
The consequences of missing a car loan payment include:
- Repossession of your vehicle, sometimes without advanced notice. If your vehicle is repossessed, you are entitled to the return of any property that was in your vehicle at the time of the repossession.
- A deficiency judgment. If the repossessed car sells for less than what you owe, you could be required to pay the remaining balance plus fees associated with repossession.
- Wage garnishment and liens on your property. That can happen if the lender gets a court order to collect a deficiency balance.
5. Credit card debt
When you default on a credit card, creditors typically charge off your account, which means they acknowledge the debt isn’t likely to be repaid. The debt might be sold to a collections company.
In addition, agreements with your creditors might specify that defaulting on any account means you’ll trigger a penalty interest rate on other unrelated credit card accounts. This practice is called universal default, according to Ross.
The consequences of defaulting on your credit card could also include:
- A lawsuit against you for the unpaid balance, fees, and legal costs
- Wage garnishment, or a court order to take money from your paycheck to pay the lender
- Lien on your property, or a legal interest on your property given to the lender by court order
- Penalty interest rates on other credit cards
What should you do if you’re in danger of defaulting?
If you’re unable to make loan payments, your lender might be willing to work with you to help avoid default. Talk to your lender about your options. Depending on your loan type, you could consider:
- Putting your loan into deferment or forbearance: For private and federal student loans, you might be eligible to temporarily pause your payments with deferment or forbearance.
- Entering into a repayment plan: Credit card companies and mortgage lenders, in particular, might be willing to rework the terms of your loan so you can afford to repay it. Federal student loans also offer specialized repayment plans that could lower your monthly bill.
- Refinancing: If your credit is in good standing, you might be able to take a new loan to pay old debt. If you can refinance your debt, you could secure a longer repayment term or a lower interest rate, both of which could make your monthly payments more affordable.
Don’t give up hope if you’re struggling to pay your bills. Once you understand what it means to default on a loan, you can explore ways to prevent it.
If the worst-case scenario happens and you do default, it’s possible to repair the damage and rebuild your credit over time.
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