When taking out a loan, you make a financial promise to pay back what you owe.
And, regardless of the circumstances or situation, when you fail to repay the funds owed as stated in the financial agreement, that means you have defaulted on your loan.
This guide explores loan default in more detail—including how it works, what happens, and what you can address to improve your financial future.
Loan Default Meaning
As stated earlier, loan default occurs when a borrower fails to make scheduled payments on their loan. Loan defaults can happen with any type of loan, including:
- Car loans
- Student loans
- Credit card
- Personal loan
- Private loan
It’s important to note that for a loan to default, you would have to miss several payments over a few weeks or months. You cannot default for missing just one payment.
For example, if you’re a couple of days behind on a monthly bill, your loan won’t default. Why? Because there’s a specified period in your agreement that states when you have to pay your loan before it defaults. The exact time frame also depends on the type of loan you took out and whether your creditor issued a grace period.
A grace period is the time frame a borrower has during which they are not obligated to make any payments. Although you have some flexibility built in, your loan will become delinquent if you regularly miss due dates on payments.
Delinquency happens when you miss multiple payments by their due dates and beyond the grace period for each. This can happen with any of the loans mentioned above, and, as you’ll read next, should be avoided if at all possible.
What Happens When You Default on a Loan?
Now that you understand the meaning of loan default, let’s discuss the consequences. When you default on a loan, there will certainly be financial repercussions, including bad credit scores and collateral repossession. Here is how default works for each loan type.
Most federal student loans won’t default until after 270 days of missed payments. However, that doesn’t mean you won’t face hardships if you fail to keep up with regular payments. In fact, 84% of student borrowers who defaulted on their loans experienced at least one consequence.
After 270 days of failing to pay back your loan, your credit score will plunge, and your lender may garnish wages, refunds, or government payments you receive.
For private loans, the financial consequences are a little different. Your loans will default after 90 days, and while lenders won’t be able to take away your tax refunds, they can take you to court. Finally, you also won’t be eligible to receive any federal financial aid.
The best way to avoid these penalties is by contacting your loan servicer ahead of time and explaining the financial setbacks you’re dealing with.
This way, you can work together and figure out a solution to get back on track financially. In the meantime, manage the amount you borrow, track your loans online, and organize your financial documents to avoid pitfalls.
When you default on an auto loan, you risk losing your vehicle and other collateral. As a reminder, collateral is what a borrower uses to secure a loan. This can be a physical asset, such as a home or car, or a financial asset, like investments. Regardless, if you default, the lender will repossess your vehicle and attempt to sell it to regain their losses.
Normally, repossession doesn’t begin until 90–120 days of missed payments. Even after the vehicle is sold, you’ll have to pay the difference between what you owe and how much the lender receives for selling the vehicle.
There are a few ways you can avoid defaulting on an auto loan. You can request a payment deferral so you have more time to make your payments. Another solution would be to refinance your loan with your lender to get a more favorable agreement. Finally, you can sell your vehicle and use the funds to pay off any leftover debt.
The consequences of defaulting on a mortgage loan include having your home repossessed and going into foreclosure. This means your lender will attempt to recover the amount owed by selling your mortgaged property. Normally, a mortgage loan doesn’t become delinquent until you’ve missed a payment for 30 days or more.
If you continue to miss payments, the lender can begin the foreclosure process by petitioning a court to start the process. If your home is repossessed, the foreclosure will show up on your credit report for seven years.
Just as with auto loans, refinancing is an option if you want to avoid defaulting on a mortgage. You might be eligible for the Home Affordable Refinance Program, which helps homeowners who have little to no equity secure an affordable refinancing deal.
You can also communicate with your lender for a loan modification—a change to the original terms so you can secure lower interest rates or an extended term length.
Generally speaking, you must miss payments for 180 days before defaulting on a credit card. However, check your credit card terms. Some credit cards will raise your interest rate to a penalty rate if you make a single late payment. If you continue to miss payments, your credit score will drop significantly because the default will be reported to a major credit bureau, and the bank will be forced to take action against you. Fees and interest rates will continue to accumulate until you make payments.
Once the 180-day period passes, they can close your account or hand your debt over to a collection agency that will aggressively hassle you until you pay the debt. The best option here is to settle what you owe with your collection agency by coming up with a reasonable offer. Whatever the agreement is, make sure you receive written confirmation.
This way, you’ll have written proof that an arrangement was finalized between both parties. The last option is to declare bankruptcy. However, filing for bankruptcy is something you should never take lightly. Bankruptcy all but destroys your credit for up to ten years.
Additionally, if you used your credit card for luxury items, you might not be able to discharge that portion of your debt.
Defaulting on Unsecured Loans
Defaulting on an unsecured loan can result in similar consequences. In the state of Texas, lenders can raise interest rates, charge extra penalties, or even file a lawsuit if you default on an unsecured loan. If you default on an unsecured personal loan, your wages will be garnished.
This means your lender will force your employer to withhold some of your earnings to pay the defaulted loan. If you took out a business loan and defaulted on it, a lender can seize your personal assets to repay the debt.
Secure Your Financial Future with Power Finance Texas
Defaulting on a loan is painful. When financial problems arise, you need a reliable lending partner to help you avoid spikes in fees and interest rates. You need Power Finance Texas.