What Does It Mean to Default on a Loan?

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 as long as 270 days for federal student loans, 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.

Learn more: How Does Default Impact Your Credit?

What Happens When You Default on a Loan?

The timeline and consequences of a default depend on the type of loan you have, as well as your lender. However, 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've missed a payment by 30 days or more. You may also be considered to be in 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 nonpayment.

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 difference, which is called a deficiency balance.

Auto Loan

Auto lenders will typically consider you in default if you've gone 30 to 90 days without making a payment, though some won't even wait that long. In fact, some bad-credit auto loans may put your loan in default if you miss a payment by a single day.

Because your auto loan is secured by the vehicle you purchased with the debt, your lender may repossess the vehicle once you've reached default status. It'll then sell the car at auction to recoup the loan balance and extra costs. If you have a deficiency balance, you may 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, so defaulting on a personal loan normally won't result in any form of asset seizure.

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, so issuers 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 Loans

Federal student loans have the longest default grace period of any type of loan, giving 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.

If you don't make a payment for 360 days, the federal government may start involuntary collection. This may include garnishing up to 15% of your wages or withholding federal tax refunds and other federal benefits to offset the amount you owe.

If you have private student loans, your lender may put your account in default after 90 to 180 days of missed payments. As with other unsecured loans, you may face collection calls and possibly even a lawsuit if you fail to pay.

Note: Perkins loans, which are managed by your school, use different rules. In some cases, you may be in default with just a single missed payment.

How Loan Default Impacts Your Credit

Because your payment history is the most influential factor in your credit score, entering default status can severely damage your credit score, and that's on top of the damage that's already been done by your missed payments.

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. This, in turn, 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 the type of loan you have and your situation, there may be several ways you can avoid loan default and its long-term ramifications. Here are some to consider:

• Talk with your lender. Default can be costly for lenders, which is why many are willing to work with struggling borrowers to help them avoid it. If you're delinquent or worried about missing an upcoming payment, reach out to your lender to discuss both short-term and long-term 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.
• Discuss a loan modification. If you don't expect your financial situation to change in a matter of months, your lender may be willing to modify your loan to make your payments more affordable.
• 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.
• Consult with a credit counselor. If you're primarily concerned with unsecured debt, credit counseling may be able to help. In addition to providing basic budgeting and debt advice, a nonprofit credit counseling agency can set you up with a debt management plan to make your payments more affordable.

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, particularly if you use a third-party debt settlement company.
• Speak with a credit counselor. As previously mentioned, a credit counselor from a nonprofit 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. Options 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

Monitor Your Credit, Even When You're Struggling

Checking your credit scores won't stop a delinquent or defaulted account from affecting them, but it's important to understand how different actions influence your scores.

With Experian's free credit monitoring, you can get real-time alerts when changes are made to your Experian credit report, and you can get insights for improving your credit. 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.