What Happens When You Default on a Loan?
Sometimes your finances don’t work out as planned. You probably intend to pay off all of your loans promptly, but life can surprise you in a number of ways—a job change or health event can quickly throw you off track. So, what happens in those worst-case-scenarios? Eventually, you may “default” on your loans, and it’s important to know how that affects you, your finances, and your credit.
What Happens When You Default?
Not surprisingly, defaulting on a loan leads to consequences. The specifics vary, depending on your situation (such as the type of loan, described below), 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 your required payments. For the first 30 days after payment is due, you’re probably in the clear. After that, lenders report missed payments to credit bureaus, resulting in lower credit scores.
Low credit scores make it hard to secure loans in the future, and low scores can impact several other areas of your life. For example, you might have a harder time renting, finding a job, signing up for utilities and mobile phone service, and buying insurance.
Eventually, lenders may send unpaid debts to collection agencies. Collections damage your credit, can result in legal judgments against you, and can be expensive. As time progresses, lenders might be able to garnish your wages or even take assets from your bank accounts.
High expenses: To make matters worse, your financial burden will probably grow if you default on a loan. Late payment fees, penalties, and legal costs might be added to your account, increasing the total balance you owe.
Types of Loans
Depending on the type of loan you default on, different things can happen.
- Secured loans: If a loan was secured with collateral like your home or car, the lender can potentially take that property and sell it.
- Personal loans: For unsecured loans (which have no linked collateral), lenders can only damage your credit and try to collect by taking legal action.
If you bought or refinanced 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 force you out through foreclosure and sell your home to collect the loan balance. Plus, if the sale doesn’t cover the entire amount you owe, you might still owe the difference or “deficiency,” depending on state laws.
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 managed to go upside-down on the loan). Repossession is possible for the original loan you used to purchase the vehicle and any title loans you’ve taken for extra cash.
You're allowed to repay student loans through using options, and possibly even postpone (or “defer”) payments when you fall on hard times. But you typically lose those options when you default on student loans. Also, student loans are notoriously difficult to resolve in bankruptcy. Federal student loans are relatively borrower-friendly, but if you default on those loans:
- The IRS can withhold tax refunds to pay off the debt.
- The Department of Education can garnish your wages very easily.
- You might receive lower Social Security payments.
Defaulting on a credit card loan is probably the most painless type of default, but your credit will certainly suffer, and your account will likely be sent to collections. Expect to see fees added to your debt, and collection agencies will make endless phone calls and other attempts to collect.
Alternatives: Avoiding Default
Given the severe potential consequences, it’s best to avoid default. Doing so keeps your options open—you can always default later, but it’s hard to clean things up after you cross that threshold.
Communication is essential when you run into financial trouble. Let your lender know if you’re struggling to make payments. From your lender’s perspective, a default appears one of two ways:
- You proactively contact your lender and attempt to work out a solution together.
- The lender discovers that you’ve simply stopped paying, so they start making efforts to collect.
The first option is best for everybody involved.
If you work out any kind of “arrangement,” be vigilant in documenting all communications, and get agreements in writing before taking action. You might have to provide personal information like your monthly income and expenses, but any type of assistance program requires those details.
Student loans provide the best options for relief, including:
The only way to know what your options are is to speak with your lender. With student loans, your loan is in default after 270 days of missed payments. Contact your lender quickly so you can line up everything well ahead of any deadlines.
Home loans can create crushing debt burdens, and there are several ways to deal with that debt.
- A loan modification may provide relief while enabling you to maintain your existing loan.
- Several government programs exist to help homeowners in trouble.
- Refinancing may help you lower your monthly payments, but you’ll need to qualify for the loan (government programs may assist if you’re already having difficulties).