What Does It Mean to Default on a Loan?
January 9, 2020
What is a default on a loan?
A default on a loan is what happens when you fail to make payments for a certain period of time. When a loan becomes defaulted, it is sent to collections. The debt collections agency then has ownership of the debt and will contact you in order to collect the payments.
Having your loan default will negatively impact your credit score and your ability to get credit in the future. If you secured your loan with an asset like your car or saving or investment accounts, the lender has the right to seize these assets to recover their losses.
What happens when you default on a loan?
As mentioned, there are many negative consequences to defaulting on a loan. The specifics vary case by case, but your credit score will be damaged, and you will likely face additional fees for late payment and collections. Lenders report missing payments to credit bureaus after they are 30 days past due. This will lower your credit score and stay on your report for 7 years, which can make it harder to secure future loans, rent a home, find a job, and more. There are also things like late fees, legal costs, and penalties you may have to pay if you default on a loan, which means the amount you must pay becomes even higher.
There are also other consequences depending on the type of loan that defaulted. If you secured the loan with your home, car, or other asset, the lender could potentially seize the property. For unsecured loans, lenders can damage your credit but cannot seize your property. They may try to collect by taking legal action and seek repayment through wage garnishment or other means.
Defaulting on student loans
Student loans allow you to repay with different options and even defer payments for certain periods, but you lose those options if you default on your loan. If you do not make payments on your federal student loans for 270-360 days and do not make other arrangements with your lender for deferment or forbearance, your loans will be in default. Student loans have a longer delinquency period, but have the consequence of “acceleration,” meaning that the entire loan becomes due immediately.
Student loan defaults stay on your record for life, even if bankruptcy is filed. The government can withhold tax refunds and sue for the right to seize wages if payment is not met. Debtors are also often charged the court collector’s legal fees.
How to avoid defaulting on a loan
Communication is key in avoiding defaulting on a loan if you are struggling to make payments. Giving your lender notice that you will not make payments on time allows you both the opportunity to come to a solution, though your lender is not required to make special arrangements. Coming to an arrangement is often best for both parties, as you can avoid default and your lender will receive payments and can avoid going to collections or court for your debt.
Student loans have the best relief options, including deferment, forbearance, and income-based payments. Specific arrangements depend on the lender, which is why communication in advance is important. After 270 days, you lose these relief options and owe your full debt.
How to get out of a loan default
For student loan defaults, there are specific programs like loan consolidation and loan rehabilitation that are meant for student loan debtors in default. Loan consolidation is a federal program that allows you to get out of default by making three consecutive monthly payments at full initial price and then enrolling in an income-based repayment plan. Loan rehabilitation is another program where you make a monthly payment that is equal to 15% of your monthly income. Student loans do not go away if you declare bankruptcy, so these programs are in place to allow lenders to recover their losses.
For other loan types it’s more difficult to find programs or loans to get out of default. It’s best to make a repayment plan with your debt collector. If your defaulted loan and severity of debt is sizeable, contact a bankruptcy lawyer to look into your financials. If you’re overwhelmed by outstanding debts and unable to pay them off, you may be able to benefit from loan forgiveness by declaring bankruptcy.
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