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 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 or don't receive late-payment notices because they recently moved or changed their contact information.
Unfortunately, defaults aren't a rare occurrence. In November 2015, Credit Karma and Qualtrics surveyed about 1,050 Americans aged 31 to 44 and found that 25 percent defaulted on a loan before they turned 30.
Student loans are the loans that respondents most commonly defaulted on, but borrowers also default on personal loans, auto loans and mortgages.
Potential Consequences of Defaulting
The consequences of a default depend on the lender and type of loan. In many cases, a loan in default may be sent to a collections agency. Going into default may also result in your wages or tax refund garnished if the creditor seeks a judgment against you.
There are also unique consequences 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, or federal loan options like deferment, forbearance or alternative repayment plans.
In the case of an auto loan, you generally have a secured loan with collateral -- your vehicle - meaning the lender may be able to repossess your vehicle if you don't repay the loan.
Preventing Defaulted Loans
The options you have to prevent a defaulted loan will also depend on the loan type and your particular circumstances.
Looking again at federal student loans, 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 a default. For example, you may be able to temporarily halt 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 and 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 Impact Your Credit
A reported derogatory mark resulting from a default can stay on your credit report for seven or more years and can severely negatively impact your credit score.
73 percent of those polled in Credit Karma's survey who had a default or account sent to collections had difficulties getting approved for financial products, leases or jobs as a result.
Fortunately, the impact of these negative marks can decrease over time, especially if you take steps to resolve them and get back on the right track financially. Not only will you no longer have the debt hanging over your head, but a resolved collections account on your credit report may weigh less on your credit over time.
Defaults can negatively affect your credit and 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.
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