What Does It Mean to Default on a Loan? Your Questions Answered
Borrowers should be cognizant of loan defaults, as they can have a considerable impact on both credit scores and personal finances.
Contributing Writer at Tally
July 6, 2022
If you are a borrower, one of the things you should be aware of is defaulting on a loan. Defaulting occurs when you stop making loan payments. It can happen with any type of loan, including personal loans, student loans, auto loans and mortgages.
In this article, we’ll answer common questions about defaulting on a loan. We start by covering the basics, such as “What is a loan?” and “What does it mean to default on a loan?” We’ll then dive into topics like the consequences of loan default, the conditions under which you can default and how defaulting impacts your credit.
What is a loan?
A loan is a lump sum of money that you receive from a lender in exchange for the guarantee of future repayments. When you repay the loan, you will likely have to pay back both principal and interest.
The types of loans with which you may be familiar include:
Private student loans
Home equity loans
The loan terms are essentially the conditions of your contract. Your loan terms will clearly define:
The principal being borrowed
The interest rate at which you’re borrowing
How long you have to repay the loan, otherwise known as the repayment schedule
Though it depends on your loan terms, many lenders require monthly payments. This means that every month, you’ll pay back a portion of your principal, plus any interest accrued. You will have a minimum payment that’s due to your lender every month.
Now that you have a better understanding of what loans are, let’s take a closer look at the question, “What does it mean to default on a loan?”
What does it mean to default on a loan?
If you default on a loan, you have stopped making payments to your lender. Typically, if you miss a couple of payments, your lender will move your account into “delinquency.” If you continue to miss payments after being in delinquency, your lender will move your account into default.
The actual timeline in which this occurs will depend on your loan terms, which clearly state what happens when you default on the loan and how many missed payments must occur before your lender can move your account into default. A lender doesn’t technically have to move your account into delinquency before moving it into default. You should familiarize yourself with these terms so that you know the amount of time you have to catch up on missed payments before you default on the loan.
Furthermore, although this information will be spelled out in the loan terms, defaulting can also vary based on your loan type. For instance, federal student loans do not allow for default until you are 270 days past due. However, lenders who issue private student loans do not have to abide by these stipulations. In fact, if you miss a single student loan payment from a private lender, your account may be moved into default 30 days after a missed payment.
There may also be other regulations by which your lender must abide. For instance, some state laws dictate how soon lenders can move into default — mortgage loans are a good example of this. As an aside, mortgage defaults, also known as foreclosures, can’t take place until a borrower is 120 days past due on their payments.
In summary, it’s important for you to familiarize yourself with your loan terms, especially if you have different types of loans. You should also make efforts to pay your minimum required payment each month so that your lender does not enter your account into default.
What are the consequences of defaulting on a loan?
Defaulting on a loan can significantly impact your personal financial situation. Below are some of the things you can expect to see if you default on a loan:
An increase to your loan balance: Your lender will charge late fees once you begin missing payments. They may add other penalties and legal fees once they begin moving your loan into default. Because of compounding interest, the actual cost of these fees could grow quickly.
Calls from debt collection agencies: Once in default, your lender may send the debt to a collection agency. At this point, you will likely begin receiving calls from debt collectors. Debt collectors can also take legal action against you, which can become expensive. This is more likely in cases of unsecured loans.
Wage garnishment and repossession of assets: Depending on how legal procedures play out, your wages may be garnished. In this case, your employer must withhold a portion of your wages until your debt is repaid. In other cases, the lender may repossess the asset that you purchased. Repossession likely occurs if you have a secured loan, such as an auto loan or mortgage.
In addition to the items listed above, defaulting on a loan will impact your credit history. Let’s take a closer look at how your credit history can be impacted.
How does defaulting impact your credit?
Defaulting on a loan will impact your credit history. Your lender will likely report the default to the credit bureaus immediately. The loan default will then stay on your credit report for seven years, even if you pay off the debt in full. This will impact the payment history portion of your credit report and will likely lower your credit score.
As a result, lenders may be wary of lending you money in the future. If you are able to find a lender who allows you to borrow money, you may face higher interest rates and stricter loan terms.
What can you do if you are close to defaulting on your loan?
If you have missed a payment on your loan, the best thing you can do is to make the payment as soon as possible. A late payment is better than a missed payment and will reset the clock on a potential default.
Additionally, if you have a large payment due and you know you are going to struggle to pay it, you may want to reach out to your lender to see if there are alternative options, especially if you’ve run into recent financial hardship. Lenders may allow a payment extension or forbearance, which is essentially a delay in the account being considered “defaulted.” The stronger your payment history, the more likely your lender is to work with you to find a reasonable solution.
Lastly, if your lender has already sent your loan to collections, you may be able to set up a repayment plan to pay off your debt. Should you default on your loan and your lender sends it to collections, you may want to work with the debt collector to understand your options and negotiate a payment plan.
Know the terms of your contract to avoid loan defaults
Any time you enter into a loan agreement and borrow money from a lender, there is a risk for both parties. The lender is taking a risk that you are going to repay the loan on time. You are taking a risk by committing to monthly loan payments and agreeing to repay what could be a tremendous sum of money.
Lenders, in an effort to mitigate this risk, can move your account into default once you begin missing payments. The time frame in which they’re able to do so will vary based on your loan terms and the type of loan. However, one thing is certain — defaulting can significantly impact both your personal finances and your credit.
If you’re looking for ways to better manage your personal finances, you’ll want to consider Tally†. Tally is a credit card payoff app designed to help you manage your due dates and pay down higher-interest credit card debt quickly and efficiently with a lower-interest line of credit.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.