You may take out a loan, fully intending to pay it back, but then the unexpected happens: You default, failing to repay your debt. Even responsible borrowers can default on loans.
Job loss, lost wages and other blows can lead to loan defaults, as can unexpected events, such as the coronavirus pandemic. The COVID-19 crisis caused financial hardship, and many homeowners couldn’t make their mortgage payments. In fact, the U.S. mortgage delinquency rate reached 8.2% at the end of June 2020, the highest since 2011, though it has since dropped back down to 3.56% as of the first quarter of 2023, according to the Mortgage Bankers Association.
So what is defaulting on a loan? First, your loan is delinquent when you fall behind on payments. When you stop paying for a certain period of time, your loan will default.
Borrowers who default on loans not only hurt their credit but also risk lawsuits and wage garnishments. Here’s what you need to know about loan default and how you can avoid it.
What Does It Mean to Default on a Loan?
A loan default is when you break your original loan agreement by discontinuing payments.
“Defaulting on a loan means the borrower hasn’t held up their end of the agreement with the creditor,” says financial attorney Leslie H. Tayne, founder and managing director of Tayne Law Group in New York.
What triggers a loan default varies by loan type and lender, she says. Many, but not all, creditors assume that if about 180 days pass without a payment from you, then you do not intend to pay, Tayne says. Default may occur at this point, but loan timelines differ.
If you’re responsible for a loan, know your deadline for default so you can take action to avoid it. Check your loan’s terms and conditions, or ask your lender to clarify. Here is what’s typical for major loan types:
|LOAN TYPE||TIME TO DEFAULT|
|Personal loans||30 days|
|Auto loans||30 days or more, depending on lender|
|Private student loans||90 days|
|Credit cards||180 days|
|Federal student loans||270 days|
What Happens When You Default on a Loan?
Default, which signals long-term lack of payment, can be damaging to your credit score, Tayne says. The top factor influencing both your FICO score and VantageScore is your payment history.
“It’s likely your scores will go down as soon as you are reported as being past due, which can occur 30 days after your due date,” says credit expert John Ulzheimer, formerly of Equifax and FICO.
A default locks in a score decrease for the next several years. “So to the extent you had a great score but then went past due and ended up defaulting, the impact could be significant,” he says.
When you default, it remains on your credit report for up to seven years, which can make qualifying for mortgages and auto loans difficult, Tayne says.
Anytime your credit is checked, a sketchy payment history can come back to haunt you. “A default can impact the costs, rates and availability of (credit),” Tayne says. “In addition, other creditors can close or reduce credit as a result of default.”
You could face more serious fallout than just the effect on your credit score:
|LOAN TYPE||EFFECTS OF LOAN DEFAULT|
|Federal student loans||Your wages may be garnished and tax refunds withheld.|
|Private student loans||You may be taken to court.|
|Mortgages||The lender may foreclose on your home and take control of it.|
|Auto loans||Your car may be repossessed and sold at auction, with any remaining debt still your responsibility.|
|Credit cards and personal loans||You may be taken to court and forced to repay your unsecured debts through wage garnishment, or a lien can be placed on your property.|
Ignoring requests for payment doesn’t make them go away. Debt collectors will just find new ways of pressuring you to pay, which can include lawsuits, Tayne says.
A lawsuit can result in a public record and a judgment against you. This means the creditor can then take more severe measures to recoup the debt, such as wage or bank account garnishment.
“A default judgment is most likely if you ignore the lawsuit or don’t respond in a timely fashion,” Tayne says. “A judgment can happen even if you answer or respond to the suit but do not have a valid legal defense other than the inability to pay.”
Why Can Loan Default Happen?
Some borrowers intentionally decide not to pay, but loan default is often caused by circumstances out of your control. “A loan may go into default because the borrower simply is unable to make payments on it for an extended period of time and is aware of missing payments,” Tayne says.
Job loss, illness and natural disaster are common reasons for default. Sometimes a borrower might forget to make payments, mistakenly believing that the loan was on autopay.
Still, defaulting on a loan is not exactly easy, says Ulzheimer.
“Every time you take out a loan, you sign a promissory note that obligates you to pay back your debt under certain terms,” he says. “I see too many people treating that note like it’s a suggestion rather than hard-and-fast rules.”
Ultimately, defaulting on a loan means you’re ignoring your obligations, Ulzheimer says.
How Can You Avoid a Loan Default?
If you can’t make your loan payment, begin by talking to your lender – ideally, before you miss the due date. Your lender may enroll you in a deferment or forbearance program or offer a loan modification.
Both forbearance and deferment allow you to temporarily stop making payments, but a major difference between them is that interest typically does not accrue on loans in deferment. These options can immediately relieve financial pressure and give you a pathway to repay your loan without defaulting.
Other choices can help you manage a loan nearing default, including:
- Consolidating debt. When you consolidate, you roll all of your debt balances into one new loan and pay off your creditors.
- Refinancing. If you think you can qualify for a lower interest rate, refinancing may lower your monthly payment. Typically, the loan term will be extended so that your payments are more spread out, but you’ll pay more over the life of the loan.
- Opening a balance transfer credit card with a 0% introductory annual percentage rate. If you are able to move a high-interest debt to a 0% APR card, that can help you make more progress on paying down the principal. While there is typically a balance transfer fee, if you can pay off most or all of the debt before the introductory rate expires, you’ll get some debt relief and come out on top.
One caveat is that you may need a good to excellent credit score to qualify for all of these opportunities. These options might be out of reach if you have defaulted or otherwise struggle with credit.
Also worth noting: “Consolidation doesn’t reduce the amount you owe, but it could potentially lower your interest rate and will simplify your monthly (bills),” Tayne says.
What Should You Do if You’ve Defaulted on a Loan?
Once you’ve defaulted, damage control is key. Take these steps to get your credit back on track:
- Pay your past-due amount. Getting your account current can stop the bleeding. If you can get and stay current, you won’t add more derogatory marks to your credit and will stop accumulating penalty fees.
- Talk to your creditor about debt workout programs. You may need to enroll in deferment or forbearance or restructure your payment plan to stay current.
- Monitor your credit. Once you’re on track, check your credit to make sure your account is being reported as current.
Whatever you do, do not ignore your debt. You can speak with a financial professional, such as a debt attorney, for advice or reach out to your loan servicer for options if you know you’re going to have trouble paying.
Your lender can also help you make a plan to pay off your loan. A simple plan can help you better manage the burden of debt on your mental and physical health and on your relationships.
“Ignoring your loan and letting it default can have disastrous long-term impacts, including increasing the balances, causing legal action, damaging your credit, or losing secured items like a car or house,” Tayne says.