What does default on a loan mean?

You may have heard the term “loan default” or “default on a loan” and wondered what it meant. It’s financial lingo for a simple concept.

Defaulting on a loan means you’ve stopped making the payments you agreed to in the terms. It applies to failing to make repayment on any type of debt, not just loans. Most of the time, you won’t be in default until you have missed several payments in a row, but this depends on the loan type and its terms.

What is a defaulted loan? It’s just a loan with payments that aren’t coming in. It’s past due.

What does it mean to default on a loan – as in what happens? In this article we’ll talk about:

• what defaulting means for different types of loans
• what happens when you default on a loan
• how to get out of loan default
• how to avoid default on loan

Defaulting on Secured Debt vs. Unsecured Debt

What does “defaulting a loan” mean, and does the type of loan make a difference? A default on a loan, regardless of the type, isn’t good. It means there are consequences, and the type of loan can determine what those are.

Knowing whether your loan is secured or unsecured is a first step to understanding what a default could mean for you.

Secured Debt

Secured loans are backed by collateral. This is valuable property owned by the loan applicant and offered as security for a loan. As a borrower, you agree in writing that if you don’t pay the loan back, the collateral may become the bank’s property.

The most common types of secured debt are mortgages, auto loans, and secured personal/business loans.

If you have a secured home mortgage and you fail to pay, the bank could eventually foreclose on the home. With a secured auto loan, the lender could repossess the car if the borrower defaults.

Unsecured Debt

Unsecured loans don’t require collateral. Because that means more risk for the lender, these loans are usually for limited amounts and may command higher interest rates.

The most common types of unsecured debt are credit cards and unsecured personal/business loans. Installment loans are a type of personal loan.

Default can still happen with unsecured debt. The consequences are just different.

What happens when you default on a loan?

So what are the consequences of defaulting on a loan? What happens?

Default on Secured Loans. If you have a secured loan, default means you’re at risk of losing the property you secured the loan with. If you cannot work with the lender and continue payments on time, that could eventually mean losing your home.

The lender would then try to sell the asset or home to recoup their losses. If the collateral isn’t enough to pay what’s owed, the lender may try to collect the remaining amount from you.

Default on Unsecured Loans. If you default on unsecured debt like medical bills or credit card balances, for example, the lender does not take any property because there was no collateral. But that doesn’t mean it’s no big deal.

Most lenders will require the borrower in default to pay the entire loan amount and interest immediately.

Your debt can also be sent to collections, with a dramatic negative affect on your credit score. You could even be taken to court or have your wages garnished (where money is taken directly from your paychecks to settle the loan). If there is a lawsuit, a judgement against you could be public record. Lenders and collection agencies will also continue to call the borrower and request payment after a default.

Keep in mind that while an unsecured loan can keep your home safe from lenders, failing to pay can destroy your credit score, which may be just as important to you in the long run. It determines whether you can get housing, insurance, a car, utilities, access to credit cards and more. And a lower credit score means it may be difficult or impossible to get another loan – even if you do, you may have to pay high interest rates (because you are now a higher risk for a lender).

These aren’t short-term problems, because a loan default stays on your credit report for seven years.

As you can see, the consequences of defaulting on a loan can vary widely depending on the type of loan. Let’s look at what a default means for several common types of loans.

Student Loans

When a borrower defaults on a student loan, wage garnishment is common. That means payments can be taken directly from your paychecks to pay the debt.

Credit Cards

If you reach default on credit card payments, you could face a lawsuit. If a judgement is made against you in court, it could be part of the public record. Your wages could also be garnished.

Mortgages

When a borrower defaults on a mortgage, the news can be dire. The home can be foreclosed on, and the bank may sell it to recover the money owed.

Auto Loans

Defaulting on an auto loan can leave you without transportation – the bank can repossess the car. This could even affect your ability to hold down a job and create a disastrous domino effect.

How to get out of loan default?

Getting out of loan default may or may not be possible depending on the type of loan. With a student loan, programs for loan consolidation and rehabilitation are available.

Depending how much you owe, it may be wise to consult with a bankruptcy lawyer and look at your financial situation. If you’re overwhelmed by debt, this is an important step.

Unfortunately, it’s difficult to find programs to help borrowers get out of default for other types of loans. That’s why avoiding default in the first place is so important.

Tips to Avoid Default on a Loan

Avoiding default on a loan is critical, and your best bet to avoid further financial issues. It can be easy to lose track of payment dates and fall into default on a loan. That’s why you’ve got to manage your accounts carefully to stay out of trouble. Thankfully there are lots of tools nowadays to help you do this. You can set up reminders for yourself, alerts in your phone, or even set up autopay to make sure the bill is paid even if you forget.

The best way to avoid a default is to be careful about taking on debt. Create a budget so you truly understand what payments you can afford. Use payment calculators and prequalify to compare loan terms. And whenever possible, save money for what you want to buy rather than paying with credit or taking out a loan.

If you know you may have problems making loan payments, it’s better to talk with your lender sooner rather than later. Call the lender and explain your circumstances. Lenders may be able to restructure the loan to make payments more manageable, giving you more time and/or reducing payments. There are also programs to postpone payment, but you must ask your lender for more information. Debt consolidation programs may also be a benefit in these situations.

The worst thing you can do in a possible default situation is to ignore or avoid the lender. If you communicate and work with them, lenders may not report late payments on your credit report. They are often willing to work with you to avoid a default before it’s too late, and that’s the best solution for everyone involved.

FAQs: Default on a Loan

How does a defaulted loan affect credit?

Defaulting on a loan will have a substantial negative affect on your credit. And a defaulted loan stays on your credit report for seven years, majorly impacting your score and thus your ability to get credit, housing, a car, utilities, credit or future loans.

How long does a default stay on a credit report?

A default stays on your credit report for seven years.

How bad is it to default on a personal loan?

Really bad. The impact on your credit score can seriously impact your ability to get housing, a car, utilities, credit, future loans and more. And the impact is lasting, since a default stays on your credit report for seven years.