What Are The Consequences of Defaulting on a Loan?

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When you stop making payments on a loan for a certain period of time, the loan goes into default. Defaulting on a loan has different consequences, depending on the type of loan and on what actions the lender takes to recoup their loss.

In this article, we’ll discuss the consequences of defaulting on a loan and what to do if you’re concerned that you might be unable to repay a loan.

Let’s jump in.

What Does It Mean To Default on a Loan?

Defaulting on a loan means that you stop making payments on your loan for a certain amount of time. When you default on a loan, the lender can send your loan to a collections agency, and your credit score can be heavily damaged. You will also have difficulty obtaining credit in the future.

Lenders on some loans will offer a grace period after a missed payment before your loan falls into default. Being delinquent is when you’re late on a loan payment but haven’t gone into default.

When you’re delinquent, you can contact your lender to make arrangements to catch up or to arrange any changes in your loan that you and the lender agree upon.

A default on your loan can stay on your credit report for up to seven years. 

What are the Consequences of Defaulting on a Secured Loan?

If you default on a secured loan, your lender can repossess the asset you put for collateral. 

For example, if you default on an auto loan, your lender can repossess your vehicle.

Likewise, if you default on your mortgage, the lender can foreclose on your house.

When your asset is repossessed, it’s typically sold at auction to cover the money that you owe the lender. However, if the asset is sold for less money than you still owe, you may still be liable to come up with the remaining balance.

As mentioned above, your credit score will also be damaged, and your ability to receive credit in the future will be hindered until the default falls off your credit report, which can take up to seven years. 

What are the Consequences of Defaulting on an Unsecured Loan?

When you default on an unsecured loan, you won’t have an asset seized because there’s no collateral put up with unsecured loans.

Typical unsecured loans, such as credit cards or personal loans, will default after you’ve not made a payment in 90 days. Between 120 and 180 days, the lender may charge off your debt, meaning they’re counting it as a loss.

From there, the lender may sell your debt to a collections agency or hire a debt collector to collect the debt from you.

The collections agency may contact you regularly to get you to repay the debt, which can be frustrating.

The collections agency may bring you to court. The court may legally make you pay your debt at this point, plus any legal fees that the collections agency paid to get the settlement against you. 

Court judgments can allow a creditor to put a lien on your house or garnish your wages.

More Information on Defaulting on a Loan

Here are some other consequences that can occur when you default on any type of loan.

• The entire unpaid balance of your loan, including unpaid interest, becomes due immediately. This is known as “acceleration.”
• You lose the ability to get a forbearance or deferment.
• Your wages may be garnished to repay the loan you defaulted on.
• You can be taken to court by your lender.
• It may take years to build up good credit again.
• Your federal and state tax refunds may be withheld and applied to the loan

The key thing to remember is that when you default on a loan, you still owe the borrowed money.

Defaulting on Student Loans

When you default on student loans, the entire balance of the loan becomes due immediately, which is called acceleration. The government can withhold your tax refunds as a means to pay back your loans. In addition, private lenders can sue you to garnish your wages.

Unlike other loans, if you default on your student loans, the default stays on your record for life, even if you declare bankruptcy. This also prevents you from taking on more federal student aid in the future.

Fortunately, it takes 270 days before student loans default, which gives you time to catch up if you’re struggling to make payments.

Defaulting on Credit Cards

Missing a credit card payment can hurt your credit score significantly and cause you to get charged late fees and have your APR raised to the penalty APR noted in your cardholder agreement.

Defaulting on a credit card generally causes a collections agency to come after you frequently to collect on the debt. Typically, if you can’t pay back the debt, you may be able to negotiate with the collections agency and settle on an amount to pay back to clear the debt.

Typical credit cards default around six months after your go delinquent. This gives you time to work out repayment with your credit card company or to secure more money to cover the amount you owe before a default occurs.

Defaulting on Mortgages

A mortgage is a secured loan that uses the purchased home as collateral. Defaulting on a mortgage typically leads to foreclosure, which can lead to the bank repossessing your home and selling it on auction.

You may be able to refinance your mortgage if you’re having trouble making payments. Refinancing can give you lower monthly payments by adjusting the interest rates or the loan repayment term.

To avoid foreclosure and potentially losing your home, contact your lender if you’re concerned that you might miss a payment. The sooner you contact your lender, the more time you’ll have to work something out with them.

Defaulting on Auto Loans

When you default on an auto loan, the lender may repossess the vehicle and sell it to recoup their loss. The challenge can be that vehicles depreciate, and the lender may not be able to get back all of their money. In this case, a lender might work with you if you’re unable to pay back your loan. This could include restructuring the loan to make payments more affordable.

What To Do If You Think You Might Default on a Loan

If you’re struggling to keep up with paying your loan on time each month, contact your lender as soon as possible. It’s better to let your lender know that you’re having trouble making payments before you miss a payment. 

A lender may decide to work with you to help keep you out of default. This could include restructuring your loan to lower you monthly payments, or the lender may offer you forbearance where you stop paying your loan for a period of time and make those payments up at the end of your loan.

Wrapping It Up

The consequences of defaulting on a loan are generally pretty serious, including a damaged credit score, the debt going to collections, and possibly a court judgment against you if you continue not to pay.

If you feel like you might default on a loan, get in contact with your lender as soon as you can, be honest about your financial situation, and discuss options.