What to Expect if You Default on a Loan

What does it mean to default on a loan? Read on to learn what happens, the consequences, and alternatives to loan default.
Last updated Nov 29, 2019 | By Miranda Marquit
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Having any sort of debt can add stress to your life. And managing debt during a period of financial hardship can add to your burden. Wondering what will happen next can intensify the struggle, as can trying to figure out how to move forward and get rid of the debt.

While meeting your obligations may be difficult, doing what’s possible to avoid defaulting makes sense, since that can come with serious consequences. So, what does it mean to default on a loan? Let’s take a look at the situation — and what you can do about it.

What does it mean to default on a loan?

Basically, when you default on a loan, you’re not meeting the terms of the loan agreement. There are a few things it can mean, including missing a payment, making a late payment, or even stopping payments altogether.

Depending on the type of loan, a lender might have different definitions of what constitutes a default. For example, a Direct student loan isn’t considered to be in default until you haven’t paid in 270 days. With a mortgage, you might be considered in default if you miss one payment and start to fall behind. With credit cards, you might not be categorized as being in default until after 90 days of nonpayment.

Understand the terms of your loans so you know what your lender considers default. In some cases, it can be easier to recover your credit score if you catch up on your account before too much time elapses.

What are the short-term consequences of defaulting on a loan?

In addition to understanding what it means to default on a loan, knowing the consequences is also vital. For the most part, any missed or late payment on any loan — whether that loan is considered to be in default or not — can negatively impact your credit score.

Here are some of the short-term consequences you might see if you default on different loans.

  • Home loans: With a home loan, the foreclosure process can start as early as 30 days from a missed mortgage payment. If the foreclosure process is completed, you could lose your home.
  • Auto loans: If you don’t meet the terms of your auto loan, the lender can repossess your vehicle. You have a time limit to bring your loan current, and if you don’t meet it, the lender can sell your car at public auction too.
  • Student loans: Even though it can take longer to be considered in default on a student loan, the short-term consequences can be tough. You can’t receive further federal aid, and you might see your tax refund seized and your wages garnished.
  • Credit cards: In many cases, you’re likely to see late fees on your missed credit card payments, increasing the amount you owe. The card issuer might decide to sell your debt to a collection agency if you continue to miss payments. If this happens, you might receive collection calls and could be taken to court and forced to pay the debt.
  • Personal loans: If you have an unsecured personal loan, the short-term consequences of missed payments are similar to what you’d see with a credit card. After your loan goes into default, the lender might turn to collections, and you could find yourself with a court order to pay the debt.

Anytime your debt goes to court, it becomes a matter of public record, so others can see what’s happened and know you’ve had problems with debt in the past.

What are the long-term consequences of defaulting on a loan?

Loan default comes with long-term consequences for your credit. Your missed loan payments can remain on your credit report for up to seven years, and if you end up declaring bankruptcy, that could remain on your report for up to 10 years. Collections and foreclosures also remain on your report for up to seven years.

When you experience a credit score drop due to missed payments and default, you might have a hard time getting a loan in the future, and it can be especially difficult to qualify for a mortgage. You might also have a hard time finding a rental if you have poor credit as a result of your default.

On top of that, some auto insurers use your credit history when setting premiums. Insurers might incorporate credit history information in their “insurance score,” so your default could impact your credit history enough for you to see an increase in your car insurance premiums.

Depending on the type of default and the length of time that has elapsed, you might see your score begin to recover within a few months. However, you need to show that you’re making changes so the old delinquencies can be pushed further back and replaced by better habits.

With student loans, as long as you are in default, you won’t be able to qualify for federal programs and benefits, and your school might even withhold your transcripts, making it hard to take the next step in your education or career.

Alternatives to loan default

If you are worried you might be heading toward loan default and hope to avoid missing payments and the consequences that come with it, you can take steps to reduce the chances of you winding up in trouble. Some of the ways to avoid loan default include the following:

  • Work out a payment plan with lenders: If you know you’re going to have trouble making payments, you can call your lender and see if you can work out a reduced payment plan.
  • Start a side hustle: You can also earn more money by starting a side hustle. Extra income can go a long way toward meeting your obligations and even paying down your debt faster.
  • Modify your mortgage: If you’re afraid of going into default on a mortgage, you might be able to get a modification with your lender. This changes the terms of your mortgage. You could see a reduced interest rate or an extended loan term, which can make your monthly payments more affordable.
  • Other options: Talk to your lender about other options. Depending on the type of loan you have, your lender might be open to deferment or forbearance, both of which allow you to avoid making payments for a set amount of time.

When you have a student loan in default, you might be able to use loan rehabilitation to get out of default. Once your loan is rehabilitated, you’re then eligible for programs like income-driven repayment that can help you avoid default in the future.

Loan default isn’t a foregone conclusion

It’s never easy to face the fact that you’re struggling with debt. Trying to find a way to meet all your obligations while still managing your money responsibly can be tough. At first, missing payments might seem like your only option. However, default isn’t a foregone conclusion.

Take a look at your situation and contact your lenders. In many cases, it’s possible to come up with a solution before you begin missing payments. While you might end up seeing a small hit to your credit score, the reality is that you’ll be in a much better place if you can avoid loan default.

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