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What are Loan Defaults and How Do They Work?

May 9, 2023

When a loan default occurs you want to be prepared to handle the situation, prevent defaults in the future, and understand what it means for your current loan.

Loan default can be a scary thing when you’re struggling to get by and are having trouble keeping up with your bills. You might not fully understand what it means to default on a loan or how to handle the situation if it arises. 

Loan Default Definition

loan default definition

Loan default refers to when someone fails to make a loan payment on time. Usually, a loan default isn’t just a single failure to make an on-time payment, but a series of missed payments or late payments. When a borrower misses enough payments or makes enough late payments, they enter into a state of loan default. 

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What Does it Mean to Default on a Loan?

When you default on a loan several things occur. For one, you aren’t up to date with the loan payments so it will take longer to finish paying off the loan. For some loans, this can also mean you’ll end up paying more in interest overall. 

The other thing that happens is that the loan borrower’s default will go on their credit history. This means that when other lenders or other applicable organizations, do a credit check or look at your credit report, they’ll see this instance when you weren’t keeping up with your payments. This could then impact whether you get approved for future loans. 

A loan default on your credit history can also negatively impact your credit score. A lower credit score can also impact your chances of getting approved for things like loans, mortgages, auto loans, and more. 

What Happens When You Default on a Loan?

what happens when you default on a loan

The first thing that happens when you miss a loan payment is your loan becomes delinquent. If your loan remains in a delinquent state for long enough (for example, 30 days or 270 days depending on the type of loan) then the loan will go into default. 

Depending on the situation, when someone defaults on a loan, that loan could be sent to a debt collector. The debt collection agency will then take on the job of contacting the borrower and acquiring the missing monthly payments.

Besides having to deal with debt collectors, the borrower could also suffer from decreased credit scores. If the situation is serious enough, the borrower could also lose property through debt collectors seizing assets to help pay off the debt

Ideally, it’s best to avoid defaulting on a loan whenever possible. If you run into a situation where it becomes difficult to make a loan payment or make on-time monthly payments, contact your loan representative and explain the situation to see what can be done. 

There is always a possibility they can change your payment schedule, decrease payment amounts with a longer loan term, or apply for a payment holiday or defer payment. 

Student Loan Default

It can be difficult to pay for your higher education without student loans. If you, like many students, have taken out student loans then you’ll want to keep loan defaults in mind so you can avoid them at all costs. 

If you are about to miss a payment or are having trouble making payments call the billing office for whatever organization or loan servicer is handling your student loans. Explain your situation and discuss your options with the student loan representative and they’ll see how best they can help you. Working alongside the lending organizations is always better than ignoring the situation only to have to deal with debt collectors later on. 

Mortgage Default

Defaulting on a mortgage can be especially risky because you risk the bank or mortgage lender reacquiring your home to repay the loan. This can then make it extremely difficult to buy any other homes in the future. 

Credit Card Default

It will depend on the credit card provider you are using, but many credit cards allow for at least one late payment before they will default your credit card amount. When taking out a credit card, be sure to read through the credit card agreement completely. That way you’ll know exactly how payments, interest rates, and late penalties work for your credit card. 

A good tip for dealing with credit cards is to use them to build credit and other useful points, but repay them in full each month. This requires not using credit cards to pay for things you can’t actually currently afford.

Defaulting On A Car Loan

If you default on a car loan then you could end up losing your car. This can make your life difficult when you need the car to get to work and run errands. Luckily, most car loan lenders and title loan lenders see vehicle repossession as a last resort and want to help you get back on track instead. 

Loan Default Consequences

Avoid defaulting on a loan whenever possible by budgeting for loans before taking them out to make sure you have room in your monthly budget for the loan payments. Below are just some of the many consequences you’ll be avoiding by not going delinquent or defaulting on a loan. 

  • Loan acceleration could occur causing you to owe more interest 
  • You may need to pay more in fees like collection fees, court costs, and fines 
  • You could lose the option for payment deferment, forbearance, or refinance
  • You could lose the option to choose your own repayment plan 
  • You could lose access to more credit 
  • It could become more difficult to get future credit 
  • The default will be marked on your credit history 
  • Your credit score could decrease 
  • Your loan may be sent to debt collectors 
  • Personal property or assets could be seized for repayment 
  • You might have to go to court 
  • Your tax refunds could be seized by debt collectors
  • Debt collectors could garnish wages by taking loan repayments right out of your paychecks 

How to Avoid Loan Default 

Ideally, you want to avoid going delinquent on a loan or defaulting on a loan. Avoid experiencing this problem by budgeting all of your monthly bills and payments carefully. Making a cash envelope budget can make budgeting monthly bills easier.

Another way to easily avoid late payments is using ACH payments or automatic payments. Then your payments are automatically set up and you don’t have to think about them! 

In Conclusion, 

Learning more about loan terms like defaulting so that you can learn how best to avoid them. Thoroughly understanding all the aspects of your loan is important to successfully pay off the loan and using loans to your advantage.