What Is Defaulting on a Loan?

Definition & Examples of Loan Default

Unhappy couple placing a "Foreclosure" sign on their home sale sign

sirtravelalot / Shutterstock

Defaulting on a loan means that you have failed to make sufficient payments for an extended period. Lenders will deem a loan in default when you haven't paid the minimum required payment for a certain number of months in a row, as detailed in your loan contract.

Loan defaults can happen with any type of loan, whether a mortgage, credit card, or a corporate loan. Defaulting on a loan obligation is serious and can affect the creditworthiness of the individual or company in default. It's important to understand the terms of your loan, how to avoid defaulting, and what you can do if you fall behind.

What Is Defaulting on a Loan?

If you take on debt such as a mortgage, a credit card balance, a student loan, or some other type of personal loan, you sign a contract with your lender. This contract is a legal document that binds you to the terms stated in it.

Your contract will state the time frame that your loan can be overdue (delinquent) before it goes into default. This can range from a month for mortgages to 270 days for a student loan.  It will also describe your lender's recourse should you default on your loan.

Most consumer loan contracts will state that legal action will be taken against you if you fail to pay or default on the loan or contract you sign.

What Happens if You Default on a Loan?

If you default on a loan such as a personal loan or credit card, you will face consequences including late fees, collection procedures, and lawsuits. When you default on a secured loan such as a mortgage or automobile loan, your lender can foreclose on your house or repossess your car. Any defaults on a loan can lead to wage garnishment, which makes it very difficult to meet your everyday financial obligations.

Loan defaults will also show up in your credit history and be reflected in your credit score. Your credit score will decline and it will be very difficult for you to get credit in the future.

Defaulting on a loan can have long-lasting effects. You might have to file for bankruptcy. Student loan defaults can follow you into retirement by lowering your social security payments and reducing any tax refunds.

Here are just a few examples of what will happen when you default on some of the most common loans.

Defaulting on a Credit Card

The first thing that will happen if you default on your credit card payments is that you'll have to pay late fees for every month you don’t make a payment. After a month, your credit card issuer will report your delinquent payment to the three major credit bureaus. After you miss two minimum payments, which is generally at the 60-day mark, your annual percentage rate (APR) will go up. When your APR goes up, it increases the amount you owe along with the amount of the late fees.

The longer you stay in default, the more your credit score will be impacted. After six months, the credit card company may charge off your account and send it to collections. At this point, your credit history and credit score are severely and adversely affected. You may be sued or forced into bankruptcy.

Defaulting on a Student Loan

Defaulting on student loans can make it more difficult to get federal student aid in the future, and your entire loan balance can even become due all at once. The good news is that student loan lenders are typically very forgiving when it comes to working out a payment plan if you become unemployed. There are programs for loan forgiveness, payment deferral, and forbearance.

Defaulting on an Automobile Loan

If you skip more than one payment, you are in danger of having your car repossessed by the lender. It will be sold at auction and if it sells for less than you owe, you will be responsible for the difference, plus expenses, or you will likely face a lawsuit.

Defaulting on a Mortgage

A mortgage default puts you in danger of losing your home. Before the bank or lending company can foreclose on the home and evict you, it has to file a notice of default with the court. After this notice is filed, you can either make an agreement with the lender or bring your mortgage up to date by paying the delinquent payments. If you can’t take one of those options, the home will be foreclosed and you will be evicted. Depending on state law, you may still have to pay on the home if it is not sold for enough to pay off the loan. You may also be liable for expenses.

Congress has made several forms of relief available to borrowers affected by COVID-19. Some mortgages are eligible for up to a year of payment forbearance, and banks are prohibited from initiating foreclosures at least through August 31, 2020. Federal student loans are currently eligible for loan forbearance and 0% interest. These changes are automatically in effect from March 13, 2020, through September 30, 2020.

Exact details may vary by loan type, but if you default on a loan, lenders can take a number of actions against you that can ruin your credit and cost you money right up to retirement.

Loan Default vs. Delinquency

It's important not to confuse loan default with delinquency. You are delinquent on a loan the first day your payment is late. This usually comes with a late fee, and you may lose other benefits, such as the grace period on a credit card. But you aren't considered in default until you're delinquent for a longer period, which varies by loan type. The consequences for defaulting on a loan are much more severe than being delinquent.

What to Do if You Default on a Loan

Rather than default on a loan, it is always best to work with the lender to find a solution. The best thing you can do is to contact your lender as soon as you think you may have trouble making payments.

If you do default on a loan, however, there are a few steps you can take. Federal student loans offer several options for loan deferment and rehabilitation, and these payment programs are usually income-based. Mortgage lenders will often work with you to help you avoid foreclosure, and credit card companies will help you to set up payment plans.

If you fall too far behind on your debts, you can explore more drastic measures such as a loan consolidation program or even bankruptcy. These aren't measures to be taken lightly, but they can provide a way to get back on track. Be sure to talk to a lawyer first.

Key Takeaways

  • When you are late on loan payments for an extended period of time, you are considered in default on your loan.
  • The exact effects of being in default vary by loan type but can include damage to your credit score, losing certain assets, and the difficulty of getting new loans in the future.
  • If you do default on a loan, you should explore debt relief and repayment plan options with your lender.

Article Sources

  1. Federal Trade Commission. "Making Payments to Your Mortgage Servicer." Accessed July 13, 2020.

  2. Federal Student Aid. "Student Loan Delinquency and Default." Accessed July 13, 2020.

  3. Experian. "What Happens If I Default on a Loan?" Accessed July 13, 2020.

  4. Experian. "What Happens If I Stop Paying My Credit Cards?" Accessed July 13, 2020.

  5. Federal Trade Commission. "Trouble Paying Your Mortgage?" Accessed July 13, 2020.

  6. Consumer Financial Protection Bureau. "Learn About Mortgage Relief Options and Protections." Accessed July 13, 2020.

  7. Federal Student Aid. "Coronavirus and Forbearance Info for Students, Borrowers, and Parents." Accessed July 13, 2020.

  8. Federal Student Aid. "Getting Out of Default." Accessed July 13, 2020.