What Does It Mean to Default on a Loan?

what does it mean to default on a loan

When you take out a loan, you promise and intend to pay it back. But one day an unexpected happens and you think you may miss a payment or two. 

That could be a bright example of how you can default on a loan. Moreover, you can be a responsible borrower who sticks to loan requirements, yet still can’t avoid loan default. 

Last year’s events are proof of emergency or unexpected things no one is immune to avoid. To add, job losses or lost wages could only renew the challenge. 

So, what does it mean to default on a loan? The result of a missed payment is a delinquent loan. Yet, if you stop paying it for a certain period of time, you will default.  

Borrowers who default on loans face a whole new chain of events. And negative consequences on your credit score are just the beginning. Thus, without further ado, let’s learn what does default on a loan mean for a borrower. 

What Happens if You Default on a Loan?

There are different types of loans and triggers that can lead to a default vary by the loan type and lender. 

As a rule, one missed payment is not enough for a lender to start the recovering process. Just because the debt collection is by far an expensive process for the lender, they’ll usually give you a chance and wait until you pay at least a few months. But again, that could vary by the lender at the terms of your loan agreement. 

So, before knowing what happens when you default on a loan, define your loan type.

  • If you’re responsible for a student loan, then you have 270 days to repay it. But that deadline is relevant for federal student loans. For private student loans, you have 120 days.
  • To prevent the default on an auto loan, apply for a car finance payment holiday. Thus, you’ll get up to six months in total to start your repayments again. But make sure you understand what happens when it comes to an end.
  • As a credit card holder, you have 180 days to term normal collections. Bear in mind, this time frame may vary by lenders. During this period, you’ll receive letters, phone calls, or other similar methods requesting you to pay what you owed on your credit card. Once the term is over, you default on a credit card, and your debt is considered a bad debt. As a result, it negatively affects your credit report.
  • If you’ve taken out a mortgage, you have a set of rules that you promise to uphold. And if you miss a few payments, you run the risk of stepping into a default. Generally, your mortgage can be considered in default once your payment is more than 30 days late. Sure, your lender might have a shorter time frame. So, if you want to keep your credit score intact and be able to borrow in the future, discuss the situation with your lender.
  • Personal loan default happens when you stop making your payments. This could be something from 30 to 90 days. So, if you’re in danger of defaulting on your loan, take the first step forward. Otherwise, you risk damaging your credit score, put your cosigner on the hook, garnish your wages, and the like.

Now, what happens if you default on a payday loan? Borrowers with payday loans in default are playing a game of chicken that they’re more likely to lose. They end up paying $9 billion in fees on those loans or $750 per person. Just because payday loans are one of the most expensive ones you can borrow, payday loan default consequences can make your financial situation even worse. If you default on the payday loan within a short amount of time, usually 14 days, extra fees start adding up to your debt.

Loan Default vs. Delinquency

When it comes to the consequences, loan default and delinquency do not carry the same weight. When you’re delinquent, you’re not making your monthly payment on time. As a result, you’re charged a late payment fee in addition to your missed payment. 

Default in turn happens when you fail to catch up on your monthly payment. Thus, aside from negative marks on your credit report, your score goes down even further. 

Why Can Loan Default Happen?

Life is not a fairy tale, and even the best of us can slip. In times when unexpected circumstances hit you, paying your liabilities becomes a challenge. This can happen because of job loss, illness, or disabilities, the choice is wide, in fact. Yet, there’re borrowers who intentionally refuse to repay their loan. 

Whatever your reason, defaulting on a loan of any type should be avoided at all costs. The consequences you’ll face would be a real challenge and would not add extra points to your karma.

Loan Default Consequences

When you’ve been approved for a loan, you have the funds available to close your financial gap. As time goes by, you might find it challenging to make monthly payments on time. As a result, your loan can be considered being delinquent. But what happens if you default on a loan?

If you have a balance outstanding for an extended period, then your loan moves from delinquency into the default state. From that moment, you can receive a notice in writing specifying that you have broken the terms of your loan agreement. You’ll receive such letters and phone calls until the moment your lenders are convinced they won’t receive the money back. Then the lender charges off your loan, which means that they remove your loan from their balance sheet. 

This, however, hardly means that you’re not accountable for paying your debt. To add, this will ruin your credit score and can be on your report for 7 years. In case you’ll pay down your debt, it still is on your report. Yet, it can reduce the impact on your credit score.

  • What happens if I close my bank account and default on a payday loan?

Bad idea. And that’s why. You gave the lender a promise to fulfill your obligations by getting money from your account. If you think that the closed account will stop them from taking your money, you’re wrong. As a result, you’ll end up accumulating extra fees from the bank every time the lender tries to withdraw the money from your account. 

What about opening an account in another bank? Generally, most banks don’t practice this method until you still owe money to another bank. The only way is to close all of your accounts to block lenders from automatic payments. 

And it doesn’t stop there. There’s always a chance that a collection agency will take you to court. Getting approved for a loan in the future can be a tough gig, too. Finally, arrest threats could be also a part of the default process.

How to Prevent Defaulted Loans?

As the saying goes, prevention is better than cure. 

Financial health is no exception, too. Thus, if you find that you are having difficulty making monthly payments, contact your loan servicer immediately. You’ll be able to request a deferment or a forbearance. 

There is also a possibility to change your repayment plan. All in all, this is your best chance to get more breathing room to get back on track and help maintain your score.

How Defaulting on a Loan Can Affect Your Credit?

Negatively. Your late payments are especially important to the credit bureaus.

Sure, it depends on how high your score is you begin with and how long you’re past due.

The FICO study suggests that being late for your mortgage for two months can drop your score up to 130 points.

So, better if you get in touch with your finance lender before your next payment is due.

What Should You Do If You’ve Defaulted on a Loan?

Now, when you know what does default on a loan mean, learn what steps to make to get your credit back on track.

  • The first thing to do is never ignore your loan. The day you apply for a loan, you think it’s the most difficult time period you could only have. Yet, things go south without warning. As a result, your poor financial health can go even worse. So, before you apply, read carefully your loan agreement to know the consequences if you default one day.
  • If you already defaulted, it’s important to pay your past-due amount. This doesn’t mean your account will recover, yet you won’t be accumulating penalty fees.
  • Opt for deferment or forbearance to restructure your payment plan and stay current. There are options, pick the best one that works for you.
  • Finally, take care of your credit score. Monitor it regularly to understand your standing. Bankruptcy is a last resort and will affect your credit rating for years.

How to Avoid a Loan Default?

First thing is to be proactive and contact your lending institution. If you‘re struggling to meet your payments, or simply want to cut costs, talk to your lender. Otherwise, you could face more serious consequences than the damaged score. 

Some lenders can offer special programs for borrowers experiencing financial troubles. You have options. Learn other choices that can help you manage a loan nearing default. 

Sure, consolidation of your debt doesn’t reduce the amount you owe, yet it could be a good way to get back on track. Also, you can opt for a lower interest rate or optimized monthly payments.

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