How Does Default Impact Your Credit?

How a Default Affects Your Credit

Lenders use credit scoring systems to forecast defaults so they can avoid them, or at least anticipate and manage them. Because a loan default indicates you've fallen behind on loan payments—or stopped making payments altogether—a default on your credit reports has a significant negative impact on your credit scores. A default entry will remain on your credit reports for seven years, with negative consequences for your credit.

The number of points a default will lower your scores is highly variable, partly because anytime you default, your scores are already falling. You'll have racked up at least two major score-damaging events: payment entries marked 30 days late and 60 days late. How many credit score points those events cost will depend on factors including what your score was when you missed the first payment, how many negative events appeared on your credit reports previously and how recent they were.

Before you default on a debt, the lender will make multiple efforts to reach you about your missed payments. It's much better to communicate with your lender before you default than after, but it still may be helpful after a default to speak with the lender (or the collection agency, if your account has been sold to one) to resolve the matter.

You'll likely have to make at least partial payments against the debts, and any settlement for less than what you owe will be noted in your credit reports, where it will remain for seven years. If you cannot make the payments needed to satisfy these creditors, your only option may be filing bankruptcy (and even that can't shield you if you've defaulted on a federal student loan).

While a credit score drop might not be unexpected after a credit default, how lenders respond to defaults vary and can be serious. The nature and speed of those responses depend on applicable laws, the amount of the loan and the loan type—but all have extreme negative consequences for your credit.

Mortgage Loan

Defaulting on a mortgage usually triggers foreclosure: seizure of the property to satisfy your obligation to the lender. The lender typically notifies you of their intention to foreclose within 30 days of the loan becoming 120 days delinquent.

In the meantime, the lender may publish its intention to foreclose in local news outlets and submit paperwork to the court documenting its right to foreclose. This is your last opportunity to halt foreclosure. If you wish to do so, it's highly advisable to hire an attorney to try to persuade the lender (or the court) to accept an alternative to foreclosure. A foreclosure stays on your credit reports for seven years and is a major red flag to lenders.

Auto Loan or Other Secured Credit

Defaulting on a car loan, or any other loan secured by property that isn't real estate (such as a boat, RV, cellphone, furniture and the like) typically triggers the repossession process. The lender has the right to seize the collateral to settle your obligation and may assign additional outstanding debt to a collections agency.

Repossessions and collection accounts stay on your credit reports for seven years, and adversely affect your credit scores as long as they remain.

Student Loan

Defaulting on a student loan brings trouble. If it's a federal loan, unless you pursue a loan rehabilitation procedure that gets payments back on track, your wages, tax returns and federal benefits (such as Social Security) can be seized to settle the debt.

Private student lenders typically turn your account over to a collection agency, which may add fees to your debt, pursue repayment relentlessly and sue to compel repayment. A collection account remains on your credit reports for seven years, with negative results for your credit scores.

Credit Card or Personal Loan

If you default on a credit card account or personal loan (both forms of unsecured credit), the lender can turn your account over to an in-house collection department or sell it to a collection agency. These entities will aggressively pursue repayment and may seek a court order that garnishes your wages or places a lien on your house. The collection entry will appear on your credit reports for seven years, hurting your credit scores.

How to Improve Your Credit

The harm to your credit from a default, and from the additional actions lenders may take in response to it, can be deep and long-lasting. But in time, you can improve your credit by adopting good debt management habits such as:

• Pay all your debts on time, without fail. On-time payments benefit your credit scores and, as we've seen, late and missed payments hurt your scores.

• Consider credit-building tools. A default and its aftermath can make it difficult to qualify for traditional loans and credit cards, but secured credit cards and credit-builder loans, products designed to enable payment patterns that benefit credit scores, can help you begin rebuilding damaged credit.

• Keep credit card balances low. Carrying balances in excess of about 30% of your cards' borrowing limits can seriously hurt your credit scores. Paying down high balances, and especially paying off your card balances every month, can benefit your scores.

• Seek only credit you need, as you need it. Credit checks associated with applications for new credit typically cause small, temporary dips in your credit scores, and multiple applications over a short time can have a cumulative negative effect on your scores.

The Bottom Line

Defaulting on a debt has major credit repercussions, and the aftermath of a default can do even more harm to your credit history and scores. Communicating with your lender(s) before you allow 90 days to pass without a payment may help to avoid the worst of these consequences.

If you've already defaulted, your credit can recover eventually. Regularly checking your FICO^® Score^☉ for free from Experian can help you track your progress as you build up your scores over time.