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When you miss one or more payments on a personal loan, your lender may consider you in default—essentially, failing to stick to your loan payment obligations. Defaulting on a personal loan can do serious damage to your credit. If you've missed one or more payments on your loan or think you will, don't panic. There are steps you can take to reduce the damage to your finances and credit. Here's what you need to know about personal loan default and how to avoid it.
When Is a Personal Loan in Default?
Personal loan default typically occurs if you go 90 days without making a scheduled payment, or in some other way fail to honor the terms as outlined in your loan agreement. However, the exact timing can depend on the lender, the type of personal loan—secured or unsecured—and the terms of your loan agreement.
Before loan default comes delinquency. A lender could consider a personal loan delinquent as soon as a payment deadline is missed, but the timeline can vary. Your lender may offer a grace period after the due date to provide you extra time to make your payment. If you don't make your payment before the end of the grace period, your loan may be considered delinquent and you could face fees. If possible, it is always best to take action to resolve a late payment before it does harm to your credit and before your loan reaches the default status.
Lenders can report a payment as delinquent once 30 days, usually a full billing cycle, elapses without payment. Once a late payment is reported to the three credit bureaus—Experian, TransUnion and Equifax—it will negatively impact your credit, even if you bring the account current. A default is likely to have an additional impact.
Consequences of Personal Loan Default
When you sign a loan agreement, you are promising to pay back the debt under the terms set out in the agreement. If you can't or don't make the payments, your loan may be considered in default and you can face consequences:
- The default can be added to your credit reports. If your payments are 30 days or more past due, they will typically be reported to the credit bureaus and remain on your credit report for seven years.
- Your credit can take a hit. Your credit score might see a noticeable drop once your account is delinquent or in default.
- You may pay higher rates in the future. If, at a later date, a lender is willing to lend to you, the interest rate will probably be much higher than it would be if you didn't default in the first place.
- The lender can take steps to recover the money you owe them. With an unsecured personal loan, your lender may make multiple attempts to contact you for payment, but at some point, it may turn your account over to an in-house or third-party collection agency to seek repayment.
- You may lose your collateral. With a secured personal loan, you may lose the collateral, like the money in your savings account, you put up to secure the loan.
- A debt collector or collection agency will try to collect. Methods they use may include garnishing your wages, putting a lien on your property and pursuing legal action against you.
If you are facing default, you have protections under the law. The Fair Debt Collection Practices Act (FDCPA) specifies what debt collectors can and can't do, such as threatening violence or physical harm against you, using obscene language or calling repeatedly to harass you.
How to Avoid Defaulting on a Personal Loan
Defaulting on a personal loan is rarely planned. If you're not in default yet, but fear it may happen soon, taking these steps can help you avoid defaulting.
1. Speak With Your Lender
Proactively calling your lender to explain your situation can go a long way in determining a better way forward. If you're experiencing a temporary setback, your lender may work with you to relieve your debt by deferring payments, coming up with a modified payment plan or suggesting another solution.
2. Tap Into Your Emergency Fund
Although not always ideal, you might consider tapping into your emergency fund or savings account if you're afraid you might miss one or more payments on your loan. Because your emergency fund is primarily meant to be used for unpredictable but essential expenses, this should only be an option if the chance of defaulting is temporary. If you've used part of your fund, map out how it will be repaid. Start small and increase the amount you can set aside as you get back on your feet.
3. Try Debt Consolidation
If your loan is not yet in default and your credit is good, you may be able to consolidate the original personal loan with a new loan and possibly stop the threat of defaulting. However, this can only work if you have a plan to pay off the new loan. If not, you may be one step away from where you were in the first place.
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4. Reach Out to Family
Asking for help from family can be awkward, but it may be your best option when you're facing default. Start by calculating how much you need, then formalize an agreement that outlines everyone's expectations and the loan repayment terms. Remember, if someone in your family cosigned for the original loan, they are on the hook for the repayments. That means your cosigner's credit will also suffer if payments aren't made.
5. Check Out Credit Counseling
If a lender isn't willing to work with you and your family can't help out, you may want to seek the help of a credit counselor. The National Foundation for Credit Counseling (NFCC) can help you find a credit counselor, usually with a free consultation.
6. Consider a Balance Transfer Credit Card
Some credit cards offer an intro 0% annual percentage rate (APR) on balance transfers, which can be used to pay off your personal loan. Your payments may be more manageable because the card isn't accruing interest during the intro period. Similar to debt consolidation, you will need a plan to pay off the credit card before the promotional period ends, or you'll end up paying interest on any outstanding balance. You'll likely have to pay a balance transfer fee, which is commonly 3% to 5% of the transferred balance.
The Bottom Line
While defaulting on a loan can negatively affect your credit score and your ability to qualify for financing in the future, sometimes it can't be avoided. Managing your money, staying on a budget and meeting all of your credit obligations in a timely manner can help keep your head above water. However, if you experience a financial hiccup, reach out to your lender sooner rather than later before the situation escalates. Then once you're on track again, regularly monitor your credit score to make sure your account is being reported as current.