When you borrow money from a lender, you make a promise to repay the loan. So if you fail to make on-time payments, your loan can go into default.
Defaults generally occur after a series of missed payments, but it could be sooner – as the exact timeline will depend on the kind of loan you have, your loan terms and any applicable law. A default means that as far as the lender is concerned, the relationship between the lender and the borrower has broken down, and they do not believe the borrower can get it back on track.
Some people might knowingly default on loans when they’re unable or unwilling to make payments. Others may unintentionally default because they don’t realise they owe the money. Sometimes people don’t receive late-payment notices, because they recently moved or changed their contact information.
Borrowers can default on personal loans, car loans, mortgages and other types of debt obligations.
- Potential consequences of defaulting
- Preventing defaulted loans
- How defaulting on a loan can affect your credit
Potential consequences of defaulting
Depending on the lender and loan type, your account could go into default after just a few payments are missed or after several payments are missed. The consequences of defaulting also depend on the lender and type of loan.
In many cases, a loan in default may be sent to the lender’s collections department or transferred or sold to a third-party debt collector.
Car loans are generally secured loans, which means that there is collateral (your vehicle) associated with the loan. If you default, the lender may be able to repossess your vehicle if you don’t repay the loan.
Preventing defaulted loans
The options you have to avoid defaulting on a loan will also depend on the loan type and your circumstances.
With many types of loans, if you think you’ll be late on a payment, you can try to let the lender know ahead of time to see if they’ll work with you to make payments more manageable. If you agree to change the terms of your contract, it’s important to get it in writing.
In all cases, understanding the terms of your loan and the implications of a default should help you weigh your options for determining your best next step.
How defaulting on a loan can affect your credit
Defaults will stay on your credit reports for six years from the default date. Even one late payment that’s reported to the credit reference agencies can hurt your credit, and continuing to miss payments can worsen the effect.
Lower credit scores can make it more difficult to get approved for other financial products and may lead to higher interest rates on loans and credit cards.
Paying off a defaulted account could help your scores by reducing your overall debt, although the marks won’t come off your credit reports any sooner. Still, you will no longer have the debt hanging over your head. And fortunately, the impact of these negative marks can decrease over time.
Bottom line
Defaults can negatively affect your credit, which could in turn affect your ability to take out loans or enter other types of credit agreements in the future. How you prevent or resolve a default depends on the lender, the type of loan and your particular circumstances, but communication is often key. Face the issues head on, and you may be able to find a solution that works for both parties.