What Happens if I Default On a Loan?

Key takeaways:

• Loan default occurs when you miss multiple payments, while delinquency occurs after missing one payment.
• Default consequences vary by loan type and whether it’s secured or unsecured, with secured loans leading to asset seizure and unsecured loans leading to potential legal action.
• If you’re struggling to repay a loan, it’s best to communicate with your lender as soon as possible to discuss repayment options and avoid default.

A loan default happens when you miss multiple payments on a loan, thereby failing to meet their obligations under the loan agreement.

The terms default and delinquent are often confused when it comes to loan repayment, so it is important to know the difference. A delinquent loan is one where you have missed at least one payment, but where you still have time to bring the loan current. A default occurs after a certain length of loan delinquency, and usually after significant effort from the lender to contact and work with you. In a nutshell, if a lender considers a loan to be in default, it essentially believes you are unlikely to resume payments on the debt.

The amount of time it takes to default on a loan varies by the type of loan and the lender’s specific policies. For example, a credit card typically isn’t in default until 180 days after the last payment was made, even though it is considered delinquent as soon as a payment is missed. For other types of loans, such as mortgages and auto loans, default can happen in a significantly shorter time. Personal loans typically reach default status about 90 days after the first delinquency.

What happens if I default on a loan?

The consequences of defaulting on a loan can be severe. The exact course of events can depend on several factors, including the type of loan and how much money you owe.

Secured vs. unsecured loan default

One of the biggest distinctions that determines what happens after a loan default is whether the loan is secured or unsecured. A secured loan is one that was based on certain collateral—for example, a mortgage is a form of secured loan, backed by the home it was used to purchase. On the other hand, an unsecured loan isn’t backed by any specific asset. A credit card is a common example of an unsecured loan.

In the event of default on a secured loan, the lender will typically seize the collateral asset(s) in order to try and recoup their money. For example, if you default on an auto loan, the lender will likely repossess your vehicle and sell it.

If you default on an unsecured loan, the lender has a few options. They’ll likely send your account to a collection agency, and may file a lawsuit against you. If they choose to pursue legal action, defaulting on a loan can result in wage garnishments as well as a legal judgment on your credit report.

Credit score impact

Most adverse credit information will stay on your credit report for up to seven years. This includes missed loan payments, defaults (also known as charge offs), and collection accounts. Usually there is a grace period before a creditor will report a late payment, but once it has been reported, any negative information can have a severe impact on your credit score.

It’s impossible to say how a loan default will impact your credit until it happens, but a charge-off is one of the worst possible things you can have on your credit report. It tells other lenders you are a high default risk when borrowing money. Once your account becomes delinquent enough that it results in a default and subsequent charge-off, your credit score will have typically fallen already, but a charge-off can make it even worse.

Legal action

Creditors can choose to pursue legal action against you if you default on a loan obligation, and this is especially common with unsecured loans. If you owe a relatively small balance, the lender might decide taking you to court isn’t worthwhile, but they will almost certainly send your account to a collection agency, which will continue to try to collect the debt.

If a lender does pursue legal action, it can result in some pretty serious consequences. Your wages could be garnished, or it could result in property liens and foreclosure. Debt collection laws and wage garnishment laws differ from state to state, so the exact course of events can depend on where you live.

What should I do if I’m struggling to pay back a loan?

One important principle to keep in mind is that default is a lose-lose situation in most cases. Lenders don’t want your loan to default. Even if a loan is secured, lenders typically don’t recoup the outstanding balance. Think of what happens if you default on a car loan. The value of the vehicle has likely depreciated significantly since you obtained the loan and may even be worth less than you owe. Plus, the lender has to pay the people who physically repossess the car, pay to get the vehicle in good condition to sell, and more.

The point is that it is typically in your lender’s best interest to work with you when you’re struggling to make your loan payments, but are making a good faith effort to pay the money back. It isn’t uncommon for lenders to restructure loan terms, temporarily pause repayment, reduce interest rates, or accept lower monthly payments until you are back on your feet. Some lenders will even negotiate a partial debt repayment, especially when it comes to credit cards.

So, if you are struggling to pay back a loan, the absolute best course of action is to get in touch with your lender as soon as possible and discuss your loan repayment options. You might be surprised at how effectively you can minimize the impact to your credit score and avoid a bad financial situation by simply letting your lender know what is going on.