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When you default on a loan, it could trigger a range of negative consequences, including damage to your credit score, foreclosure or repossession, collection calls and even a lawsuit.
While it's best to try to avoid default, there are situations where it may be unavoidable. Here's what you need to know about when default occurs and what you can expect.
What Does It Mean to Default on a Loan?
Loan default occurs when you've stopped making payments on a loan or credit card according to the account's terms. In many cases, lenders give borrowers a grace period, which can range from 30 days to several months, before considering them to be in default.
With some lenders, however, you may be in default as soon as you miss a payment. Review your loan or credit card agreement carefully to understand when you're at risk of defaulting on your account.
What Happens When You Default?
The terms and consequences of a default depend on the type of loan you have and the lender. That said, here are some general guidelines for what you can expect with some of the more common loan options.
Mortgage Loan
Defaulting on your mortgage loan can occur once you're past due on a payment by 30 days or more. Alternatively, you may default if you fail to pay your property tax bill or homeowners insurance premium or breach your loan agreement in another way outlined by your lender.
Once you've defaulted, the lender may accelerate your loan, requiring you to pay the entire remaining balance. At that point, you could try to negotiate with your lender. But if you can't come to an agreement, the lender may opt to foreclose on the property after 120 days of non-payment.
The lender would then evict you and sell the home at auction to recoup the remaining loan balance. Note that this can also happen if you default on a home equity loan or home equity line of credit.
If the lender doesn't get enough to cover the full amount you owe, you may still be on the hook for the deficiency balance.
Auto Loan
In most cases, auto lenders won't consider you to be in default until you've gone 90 days without making a payment, though some may not wait that long.
Like a mortgage loan, an auto loan is secured by the asset you purchased with the debt: your vehicle. As a result, your lender may repossess the vehicle once you've reached default status, then sell it at auction to recoup the loan balance and extra costs.
If you have a remaining deficiency balance, you may still be required to pay it.
Personal Loan
With a personal loan, default typically occurs once you've gone 90 days without making a payment. Most personal loans are unsecured, which means you don't need any collateral to get approved. As a result, defaulting on a personal loan normally won't result in a repossession.
However, the lender will typically send your account to its in-house collection department or sell it to a collection agency, and you'll start receiving collection calls. If that doesn't work, the lender or collection agency may sue you to seek a court order for repayment, which can include wage garnishment or a lien on your property.
If you took out a secured personal loan, using a savings account balance or another asset as collateral, the lender may seize the collateral to cover the remaining debt.
Credit Card
Credit card issuers usually give you a grace period of 180 days with no payments before putting your account in default. As with personal loans, most credit cards are unsecured and may attempt to collect the debt on their own or sell it to a third-party debt collector.
If collection efforts fail, the lender or agency may file a lawsuit and seek court-ordered repayment via a wage garnishment, liens or other methods.
If your credit card is a secured card, the card issuer will typically close your account and use your security deposit to cover what you still owe.
Student Loan
Federal student loans have the longest default grace period of any type of loan: Loan servicers give you 270 days after your first missed payment to get caught up.
At that point, your entire loan balance will become due immediately, and your loan servicer may tack on a variety of collection fees. It may also take you to court. In addition to wage garnishment, the federal government may also withhold your tax refunds and federal benefits to offset the amount you owe. Fortunately, it's possible to reverse federal student loan default.
If you have private student loans, your lender may put your account in default after 90 days of missed payments. As with other unsecured loans, you may face collection calls and possibly even a lawsuit if you fail to pay.
How Loan Default Impacts Your Credit
Defaulting on a loan of any kind means that you've missed one or more payments or stopped paying altogether. Because your payment history is the most influential factor in your credit score, entering default status can have a severe negative impact on your credit score.
That's on top of the damage that's already been done by your missed payments. For most loans, lenders report a missed payment after 30 days—federal student loans are the primary exception, giving you 90 days until your loan servicer reports that you're past due.
For both late payments and defaults, the derogatory mark will remain on your credit reports for seven years from the date of the first missed payment.
Other potential impacts include:
- Credit utilization: If a credit card issuer closes your credit card, you'll lose the account's available credit, which could cause your credit utilization rate to spike, damaging your credit until you pay it down.
- Length of credit history: If defaulting results in a lender closing one of your older credit accounts, it could negatively impact your length of credit history and hurt your credit score.
- Credit mix: Being able to manage different types of credit can help improve your credit score. But if you default on a loan or credit card, it could limit the diversity of your credit mix and negatively affect your credit score.
How to Avoid Defaulting on a Loan
Depending on your situation, there may be several different options to avoid loan default and its long-term ramifications. Here are some to consider:
- Talk with your lender. Default isn't just expensive for you; it's also costly for lenders. As a result, many of them are willing to work with struggling borrowers to help them avoid default. If you're delinquent or worried about missing an upcoming payment, talk with your lender to learn about relief options.
- Ask about deferment or forbearance. With some types of loans, you may be able to request deferment or forbearance on your loan payments. These plans may be able to give you a short-term reprieve while you work to get back on your feet financially.
- Consider debt consolidation. If your credit score is in good shape, you may be able to consolidate your debt with a new loan. This process pays off the original debt and ideally neutralizes the threat of default. This option is best considered if you are having difficulty keeping up with several debt payments and have a plan to pay off the new loan. If not, you could just be delaying the inevitable.
What to Do if You've Defaulted on a Loan
If you've already reached default status on a loan or credit card, here are some steps you can take to minimize the negative impact:
- Try to negotiate a settlement. You may be able to negotiate with the lender or collection agency to settle for less than what you owe. However, you may need to make a lump-sum payment, which can be difficult if you're already behind on payments. Keep in mind, though, that a debt settlement can also damage your credit.
- Speak with a credit counselor. A credit counselor from a nonprofit counseling agency can provide free, personalized guidance for your situation. They may also be able to help you get on a debt management plan, which can offer some relief with your debt.
- Consider other options for student loans. If you have federal student loans, talk to your loan servicer about ways to get out of default, which may include student loan consolidation or rehabilitation.
- Consider bankruptcy. If your financial situation is in dire shape, bankruptcy may be the only option. Consult with a bankruptcy attorney to learn more about whether this can be a good option. Additionally, make sure you understand the potential impact of filing for bankruptcy on your credit score.
Frequently Asked Questions
Delinquency begins the moment you've missed a payment. You'll typically be charged a late fee, and your lender will begin to make collection attempts. You may be considered delinquent for anywhere between 30 and 90 days—and sometimes longer—before the lender considers you to be in default.
When the lender determines you are in default, collection attempts typically begin in earnest, either through the lender's own collection department or a third-party agency.
Ultimately, it depends on the type of loan you have and the lender. In some cases, you may be considered in default immediately upon missing a payment. In others, the lender may not put your account into default status until you've gone several months without paying. Check your loan or credit card agreement to find out more about your lender's policy.
Defaulting on a loan can have a significant negative impact on your credit score. Other consequences can vary depending on the type of loan you have. Potential ramifications include foreclosure or repossession, collection calls or a lawsuit that could result in wage garnishments, liens and more.
Monitor Your Credit When Struggling With Payments
Checking your credit score won't stop a delinquent or defaulted account from affecting it, but it's important to understand how different actions influence your score.
Monitoring your credit can also help you stay motivated to make monthly payments and avoid allowing a delinquency or default to happen in the first place.
