What Happens when you Default on a Loan?

Past Due, Overdue Notices
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Sometimes things don’t work out the way you planned.  It’s always best to pay off loans, but it’s nice to know what could happen in a worst-case-scenario. In general terms, when you stop making payments on a loan, you “default” on the loan. So what does that mean for you, your finances, and your credit?

What Happens when you Default?

Defaulting on a loan, as you might imagine, comes with consequences.

The specifics depend on your situation (see below for details on different types of loans), but you can usually count on damage to your credit and additional expenses.

Credit and legal troubles: your credit will suffer when you fail to make payments as agreed. For the first 30 days after payment is due, you’re probably in the clear. After that, missed payments will get reported to credit bureaus, resulting in lower credit scores. Lower scores make it hard to get loans in the future – and credit scores can impact other areas of your life as well. For example, you might have a harder time renting, getting a job, getting utilities or mobile phone service, and buying insurance.

Eventually, unpaid debts can be sent to collection agencies. Collections damage your credit, can lead to legal action, and can be expensive. Eventually, lenders might be able to garnish your wages or even take assets from your bank accounts.

Expenses: to make matters worse, your financial burden will probably grow if you default on a loan. Late payment fees, penalties, and legal expenses might increase your loan balance.

Types of Loans

Depending on the type of loan you default on, different things can happen. If a loan was secured with collateral like your home or car, the lender can potentially take and sell your property.

If the loan was unsecured (or not linked to any collateral), lenders can only damage your credit and try to collect by taking legal action.

Homes: if you bought a home with your loan (or borrowed against it with a home equity line of credit or second mortgage), your lender might be able to sell your home and force you out through foreclosure. If the sale doesn’t cover the entire amount you owe, you might still owe the difference or “deficiency”.

Automobiles: auto loans are similar. If you default on a car loan the vehicle can be repossessed and sold. Again, you might owe any deficiency if the car sells for less than you owe (which can happen due to quick depreciation or if you’ve somehow gotten upside-down on the loan). This can happen with the original loan you used to purchase the vehicle, or any title loans you’ve taken for extra cash.

Student loans:  student loans allow you to repay using different options and possibly even postpone (or “defer”) payments when you fall on hard times – but you lose those options when you default on student loans. In addition, student loans are notoriously difficult to get rid of in bankruptcy. If your loans were backed by the federal government, you might find that the IRS withholds your refunds to pay off the debt.

What's more, the Department of Education can garnish your wages very easily.

Credit cards: defaulting on a credit card loan is probably the most painless default, but your credit will certainly suffer and your account will likely be sent to collections. You’ll likely see fees added to your debt, and collection agencies will make endless phone calls and other attempts to collect.

Alternatives: Avoiding Default

Given the consequences, it’s best to avoid default. Doing so keeps your options open – you can always default later, but cleaning up after it happens is a challenge.

Communication is essential when you run into financial trouble. Let your lender know if you’re having a hard time making payments and at risk of default. From your lender’s perspective, they can either:

  • Get a heads up and have the opportunity to (potentially) work with you, or
  • See that you’ve simply stopped paying, and start making efforts to collect

The first option is probably best for everybody involved.

If you work out any kind of “arrangement,” document all communications, and get agreements in writing before taking action. You might have to provide personal information like your monthly income and expenses, but those details might be required for any assistance.

Student loans have the best options for relief, including:

The only way you’ll know what your options are is to speak with your lender. With student loans, your loan is in default after 270 days; be sure to contact your lender quickly so you can get everything lined up well ahead of any deadlines.

Home loans can sometimes be modified, and several government programs exist to help homeowners in trouble.

For debt in general, it might be helpful to talk with a licensed credit counselor who can help you evaluate your financial position, and who can possibly even set up a debt management plan (if appropriate in your situation).