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- Defaulting on a loan happens after you miss payments for a set period.
- When you default on a loan, your credit score will suffer.
- Depending on the loan type, lenders can repossess collateral or get repayment through other options.
Introduction
You may have taken out a loan to finance a number of purchases — for instance, a house, a car, or your education. However, if you fall behind on your payments, your loan may go into default, which can come with some serious consequences.
No one wants to default on a loan. But, in case you do, it's helpful to understand the implications.
Definition of loan default
Defaulting on a loan happens when you miss payments for a certain amount of time. In other words, failing to keep up your end of a loan agreement can eventually push your loan into default.
Defaulting on a loan can damage your credit score significantly, cost you thousands in accumulated interest, and prevent you from getting another loan in the future.
If you default on a secured loan, the lender may have the right to repossess your collateral. For example, if you default on your mortgage payments, the lender can foreclose on your home. If you default on unsecured debt, the lender cannot immediately claim your assets. However, the lender can pursue legal action to obtain payment.
Difference between default and delinquency
Before you officially default on the loan, there is often a grace period, called delinquency, between missing a payment and defaulting on the loan. The length of the delinquency period varies based on your loan, but it kicks off as soon as you miss a payment. Depending on your loan type, this grace period is often in the range of 30 to 90 days.
How loan defaults work
While the exact number of days varies depending on the type of loan and lender, you can expect your loan to fall into default after you've missed payments for a set period.
If you are falling behind on your payments or fear you might, reach out to your lender immediately. Ask about deferment options, which involve a temporary pause to your payment obligations for a set period. Even a short reprieve might give you enough time to get back on track with your loan payments.
If your lender will not grant a deferment, here's how much time you may have before you are in default. Of course, the numbers in the chart below are only estimates. If you need specifics, reach out to your lender to better understand their rules.
Loan type | Standard amount of time until loan considered default | Standard amount of time until nonpayment reported to credit bureaus |
Student loan | 270 days | 90 days |
Auto loan | 30 days | 30 days |
Personal loan | 30 days | 30 days |
Mortgage | 30 days | 30 days |
Causes and consequences of loan default
The type of loan you default on comes with different consequences. Depending on the type of loan, you may have your wages garnished, collateral seized, or home foreclosed upon. As your default period stretches out, you may also rack up thousands of dollars in unpaid interest.
"Most loan agreements for homes and vehicles also allow for the physical repossession of the property if the debt is in default," says Todd Christensen, an AFCPE-Accredited Financial Counselor. "While the lenders don't typically want to repossess your vehicle or foreclose on your home, they will begin these proceedings if they feel it is their least worst option."
Additionally, defaulting on a loan can do damage to your credit score, and it's difficult to repair your credit. Payment history accounts for 35% of your FICO score.
Importantly, it is not a crime to default on a loan. No lender can have you arrested for failing to pay a loan. Defaulting on a loan may be a civil offense, and you might have to appear in court. But you won't serve jail time for defaulting on a loan.
Mortgages
Missed payments on your mortgage comes with serious consequences that could include losing your house. After three missed payments, your lender can start the foreclosure process.
One of the ways to avoid a default is to refinance your mortgage. If you have enough equity in your home, refinancing could lower your monthly payments to make them more affordable. Lenders tend to view foreclosure as a last resort and may agree to a forbearance if you request one. This allows you to pause your mortgage payments for a certain amount of time or, in some cases, make reduced payments instead.
Student loans
Federal student loans are tightly regulated under law, with serious penalties for those who don't pay.
Before a student loan goes into default, borrowers have several options to prevent a negative credit impact, including requesting a different payment plan, asking for a forbearance, or refinancing their loans.
When a student loan goes into default, borrowers may be blocked from buying a house, and the loans may not be resolved under bankruptcy.
Personal loans
The consequences of defaulting on a personal loan depend on what kind of loan it is: secured vs. unsecured. Secured loans are backed by collateral, such as an automobile or other asset. Unsecured loans do not require collateral and are approved on the basis of the borrower's creditworthiness.
Most personal loans are unsecured. In this case, the lender can send the debt to a debt collection agency, which can sue you to recover the funds. Ultimately, a judge could decide to garnish your wages or place a lien on your assets. With a secured loan, the lender has the right to seize whatever you put up as collateral if you default on the debt.
Credit cards
Credit card debt is unsecured, meaning it is not backed by collateral. If you default on your credit card debt, the issuer may send the debt to collections. By this point, your account balance will probably already have grown significantly because of the late fees and accrued interest.
In a worst-case scenario, you could face wage garnishment or have a lien put on your home or other assets if the debt collector sues you to recover the funds.
Auto loans
Auto loans are secured loans, with the lender holding a lien on your vehicle's title until the debt is paid off. If you default on your auto loan, the lender is entitled to repossess the vehicle to cover the outstanding debt.
Repossession is usually not in the lender's best financial interest. Many will agree to restructure your loan if you ask them. Extending the term of your loan will lower your monthly payment. But in the long run, you'll pay more in interest.
How to avoid loan default
Effective debt management strategies
If you are facing default on your loans, consider loan consolidation. When you consolidate your loans,you get a loan from one lender for the total amount of debt you'd like to combine. Then, you use those funds to pay off the individual, smaller debts. At the end, you have all of your debt rolled into one monthly payment, one deadline for debt repayment, and a smaller interest rate.
Communicating with lenders
"Communication is the key component," says Ryan Cicchelli, founder of Generations Insurance & Financial Services. "As long as you stay in consistent contact with them and take advantage of any hardship assistance they may offer, the chances of defaulting on a loan diminish substantially."
Loan rehabilitation options
For federal student loan borrowers, loan rehabilitation is a possibility. When signing up for loan rehabilitation, you'll need to agree to make nine voluntary and affordable monthly payments within 20 days of the due date over a consecutive period of 10 months.
Other options include working with a credit counselor. Depending on the size of your defaulted loan, you may also consider bankruptcy as an option of last resort.
FAQs
The timeframe for a loan to go into default varies by lender and loan type. For example, federal student loans enter default after 270 days of non-payment, while other lenders could declare a default after a shorter period.
If reported accurately, a loan default cannot be removed from your credit report and can stay on it for up to seven years. However, improving your credit behavior over time can mitigate the negative impact.
You can prevent loan default by communicating with your lender as soon as you sense financial trouble. Many lenders are willing to work with borrowers via loan modifications, repayment plans, or forbearance.
If you default on a secured loan, the lender can seize the collateral associated with the loan, such as your home in the case of a mortgage, or your car with an auto loan.
In many cases, you can negotiate a loan default settlement. Lenders tend to be open to settlements on defaulted loans, but negotiating a settlement typically requires lump-sum payment and can still hurt your credit.
