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When you borrow money from a lender, you make a promise to repay the loan. So if you fail to make on-time payments, your loan can go into default.
Default can occur immediately after a missed payment or months later, as the exact timeline will depend on your loan terms and state or federal laws.
Some people might knowingly default on loans when they’re unable or unwilling to make payments. Others may unintentionally default because they don’t realize they owe the money. Sometimes people don’t receive late-payment notices, because they recently moved or changed their contact information.
Unfortunately, defaults aren’t an especially rare occurrence. The U.S. Department of Education reports that 11.5% of students who started making federal student loan payments in 2013 had defaulted within two years. And according to the Federal Reserve Bank of St. Louis, 2.53% of commercial banks’ credit cards wound up in default during the third quarter of 2017.
Borrowers may also default on personal loans, auto loans, mortgages and other types of debt obligations.
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Potential consequences of defaulting
Depending on the creditor and loan type, your account could go into default after a single missed payment. Or your account could be considered delinquent only after you miss several payments in a row. The consequences of defaulting also depend on the lender and type of loan.
In many cases, a loan in default may be sent to the lender’s collections department or sold to a third-party collections agency. Going into default may also result in your wages or tax refund being garnished if the creditor seeks a judgment against you.
There are also unique circumstances associated with certain types of loans. For example, if you have a federal student loan in default, you may not be eligible for additional federal student loans, federal loan options like deferment and forbearance, or alternative repayment plans. However, unlike some other types of debt, you may be able to rehabilitate your federal student loan, get it out of default and get back on a repayment plan.
Auto loans are generally secured loans, which means that there is collateral (your vehicle) associated with the loan. If you default, the lender may be able to repossess your vehicle if you don’t repay the loan.
Preventing defaulted loans
The options you have to avoid defaulting on a loan will also depend on the loan type and your circumstances.
For example, if you’re having trouble making on-time payments on your federal student loans, there are certain options you may be able to take before defaulting. One option may be temporarily halting payments without a penalty by going into deferment or forbearance.
With many types of loans, if you think you’ll be late on a payment, you can try to let the lender know ahead of time to see if they’ll work with you to make payments more manageable. If you agree to change the terms of your contract, it’s important to get it in writing.
In all cases, understanding the terms of your loan and the implications of a default should help you weigh your options for determining your best next step.
How defaulting on a loan can affect your credit
Derogatory marks, including late payments, collection accounts and defaults can stay on your credit reports for up to seven to 10 years. Even one late payment that’s reported can hurt your credit scores, and continuing to miss payments can worsen the effect.
Lower credit scores can make it more difficult to get approved for other financial products and may lead to higher interest rates on loans and credit cards. Derogatory marks on your credit reports could also hurt a job search.
Paying off an account that’s been sent to collections or is in default could help your scores by reducing your overall debt, although the marks won’t come off your credit reports any sooner. Still, you will no longer have the debt hanging over your head. And fortunately, the impact of these negative marks can decrease over time.
Defaults can negatively affect your credit, which could in turn affect your ability to take out loans or enter other types of credit contracts in the future. How you prevent or resolve a default depends on the lender, the type of loan and your particular circumstances, but communication is often key. Face the issues head on, and you may be able to find a solution that works for both parties.