Loan Default: What Happens When You Default On A Loan?

When you take out a loan and sign the agreement with your lender, you likely do so with every intention to repay the loan in full. However, if your financial circumstances change due to a major life event and you’re no longer able to keep up with the loan payments, you may be at risk of loan default.

What is defaulting on a loan, though, and what are the consequences? Let’s learn about loan default and how to avoid it.

What Does It Mean To Default On A Loan?

When you can’t make your monthly payments and your account is delinquent, you’re at risk of defaulting on the loan. A loan default can happen when you fail to repay the debt within the terms of your initial loan agreement, meaning that you’re unable to fulfill the legal requirements of the loan.

You’ll typically need to miss a succession of monthly payments before defaulting on your loan, though it’s possible to default after a single missed payment. How quickly you default can vary greatly depending on the type of loan and the lender.

When you miss a single monthly payment, many lenders will allow your loan to go into a delinquency phase. In this delinquency period, you’ll have time to avoid defaulting on your loan. You can do this by catching up on the missed payments or contacting your loan provider and asking how you can best avoid default.

You should check the details of your type of loan. In addition to the interest rate and payment information, your loan paperwork should outline any grace period for late payments and any late fees you’ll face. With that information in hand, you’ll be better prepared to avoid defaulting on your loan.

If you have the opportunity to avoid defaulting on your loan, you should always pursue it. A loan default can have a negative influence on your finances for a long time.

Loan Default Consequences

Loan default can lead to significant ramifications for your credit score, finances and more. Consequences can differ significantly based on the type of loan in default, so let’s take a look at what happens when you default on certain loans.

Credit Score Impacts

The biggest immediate impact when defaulting on a loan is a major dip in your credit score. Once your loan servicer reports your default to the credit bureaus, you should expect a big dent in your credit. Unfortunately, the credit impacts of loan default are dramatic and long-lasting.

In fact, a loan default can remain a dark spot on your credit report for up to 10 years. Although a single late payment can negatively impact your credit score, the credit consequences of defaulting on a loan are more significant.

A hit to your credit score can have a wider impact on your finances. As you seek out future loan opportunities, you’ll likely face higher interest rates and less favorable loan terms.

Financial Repercussions

The financial consequences of loan defaults hinge greatly on the type of loan. For example, borrowers with federal student loans will be forced to deal with loan “acceleration.” Essentially, this means that if you default on a loan from the U.S. Department of Education, the entire balance of the loan will be due immediately. If you’re unable to pay off the entire balance at once, the government may choose to withhold your tax refunds and other federal benefits until the debt is repaid.

An additional consequence of defaulting on federal student loans is that you won’t be able to qualify for loan deferment or forbearance once you’ve defaulted. Finally, defaulting on a federal student loan will prevent you from qualifying for federal student aid in the future.

Asset Repossession

If you default on a secured loan, you’ll face repossession of the secured item. One example is your mortgage loan, which is secured by your home. If you default on the mortgage, you’ll have to return the property to the lender through foreclosure. Another example is auto loans, which are typically secured by the vehicle. If you default on the loan, your car may be repossessed.

Legal Issues

Defaulting on unsecured loans, such as personal loans or credit card debt, won’t lead to the repossession of your belongings. However, it can lead to legal action by the creditor.

The creditor has the right to sue borrowers who default on a loan. Once in court, they can push for repayment options such as wage garnishment or liens on your assets.

Emotional Stress

A major burden when defaulting on a loan that’s often overlooked is your personal emotional toll. Through the process of defaulting on a loan, you may encounter debt collectors from collections agencies who call, email and text you to collect on the defaulted funds. Additionally, the pressure of avoiding default causes stressful situations.

For your personal knowledge, see the chart below featuring default ramifications and delinquency periods by loan type.

How To Prevent Loan Default

The financial, legal and emotional consequences of defaulting on a loan can leave a lasting impact on your life. With that, it’s important to avoid this situation if possible.

As you contemplate your options for avoiding default, you’ll need to consider the unique circumstances surrounding your loan. But you still have a few options, such as those described next.

1. Contact Your Lender

If you know that you’re heading for default, contact your lender as soon as possible. Most lenders will be willing to work with you to keep you out of default. You can explain your predicament and collaborate with the lender to come up with a new repayment plan.

2. Consider Deferment Or Forbearance

Depending on your lender, you may be able to use deferment or forbearance options to ease your financial pressure right now. Loan deferment allows borrowers to temporarily stop making the principal and interest payments on the loan. The duration and repayment stipulations of the deferment period vary by lender.

If you don’t qualify for deferment, a forbearance will allow you to stop making principal payments or reduce your monthly payment for up to 12 months. However, both of these options can have long-term financial impacts, so work with your lender to figure out the best way forward.

3. Look Into Debt Consolidation

Debt consolidation is a payoff strategy some borrowers use to make their debt repayment more manageable. This strategy involves taking out an unsecured loan, such as utilizing a personal loan, that liquidates all of your outstanding debts and leaves you with only a single monthly payment and interest rate to think about.

In addition to simplifying multiple debt payments, it’s possible you’ll save money in the long run with a new interest rate.

4. Contact A Credit Counselor

Working with a credit counselor is one debt relief strategy that can help you devise a new plan of attack for tackling debt. If you’re struggling to make on-time payments, a credit counselor could be a helpful contact.

5. Talk With A Lawyer

If you’re already in default, contact a lawyer to understand your legal options. It’s important to seek out legal counsel who has experience working with your specific type of loan default.

Final Thoughts

Defaulting on a loan can wreak havoc on your finances for years to come. Take some time to consider your loan repayment options and come up with a game plan before falling into default. It’s important to take action to prevent default if at all possible.

For debt consolidation options, get the approval process started today with Rocket Loans℠ and see the personal loan rates you qualify for.