What Happens If You Default on a Loan?

what happens if a borrower defaults on their loan

Defaulting on a loan happens. Nobody takes out a loan without the intention of not paying it back and banks don’t lend their money to people they don’t think can repay it. But sometimes the unexpected happens and the borrower can’t afford the loan payment. Maybe an emergency medical expense came up that was more important than a loan payment or maybe they lost their job and can’t afford it. 

No matter the reason for why you can’t or didn’t pay your loan, you need to know what happens when you default on your loan. 

In this article, you will learn: 

  • What Is Defaulting on a Loan? 
  • What Happens if You Default on a Loan?
  • What Are the Consequences of Defaulting on a Loan?
  • What Should You Do if You Are Going to Default on Your Loan?
what is loan default

What Is Defaulting on a Loan?

Default is when the borrower fails to pay back the loan and doesn’t hold up their side of the loan agreement. As we mentioned, there are a variety of reasons the borrower may not be able to pay the loan, but regardless of the reason, the result is the same—the borrower can’t pay the loan and the lender has a legal right to take action. 

Typically, a loan default begins when a borrower misses a scheduled payment. However, missing a single payment doesn’t always result in an immediate default. Most lenders will provide a grace period during which the borrower can make the missed payment without incurring penalties. If the borrower continues to miss payments, the loan can go into default after a certain period, as specified in the loan agreement.

Every loan and loan agreement is different. Depending on the type of loan you took out, default can occur right after the initial missed payment or even months later following a grace period where you have the ability to repay the missed payment. For a mortgage loan, you have 30 days after your last payment until you default. There is a 15-day grace period where you can make a late payment before defaulting. 

Other loans have longer or shorter default times. Credit card loans have 180 days until you default, and you are allowed to miss 1 payment before being penalized, while student loans give you 270 days before defaulting with a 90-day grace period to make a payment. 

Default vs. Delinquency: What’s the Difference?

Don’t get confused between default and delinquency—they don’t mean the same thing.

Delinquency refers to missing a payment or being late on a payment, while default means the loan has reached a status where the entire amount is deemed due immediately. This is often because multiple payments have been missed or other terms of the loan agreement have been violated.

What Happens If You Default on a Loan?

If you have missed a payment on your loan, the lender will first try to contact you to figure out the reason your payments are missing or are late. Sometimes there are mistakes, whether it’s user error or an accounting error on the lender’s part, where it’s a simple fix. 

If they call and find that it wasn’t a mistake and you truly will default on your loan, they will do their best to work with you to reach a reasonable solution. The lender may suggest a repayment plan to make your loan more affordable for the time being. Things like reducing interest, putting your loan in forbearance, or creating a customized payment plan may be brought to the table during these talks. 

For the most part, the lender wants you to keep making loan payments. They make their money off the interest of each payment, that’s why they want to come to a reasonable solution. They lose money when they don’t get payments and have to chase borrowers down for missed payments which can be an expensive process. 

Although lenders may be flexible, depending on your situation, there are consequences of defaulting on your loan. 

Consequences of defaulting on a loan

Consequences of Defaulting on Your Loan 

Defaulting on a loan has a series of consequences, both immediate and long-term. The specific ramifications can vary based on the type of loan, the jurisdiction, the terms of the loan agreement, and the lender’s policies.

Here’s a general overview of what can happen:

  1. Late Fees and Penalties: Once you miss a payment, most lenders will charge a late fee. If you continue to miss payments, these fees can accumulate.
  2. Increased Interest Rate: Some loans, especially credit cards, might have provisions that allow the lender to increase your interest rate if you default.
  3. Acceleration of Debt: In some cases, defaulting can cause the entire loan amount to become due immediately. This is called acceleration. Instead of just owing a monthly installment, you could owe the entire remaining balance of the loan at once.
  4. Negative Impact on Credit Score: Defaulting on a loan will almost certainly be reported to the credit bureaus, leading to a significant drop in your credit score. This negative mark can stay on your credit report for several years, making it more difficult and expensive to obtain credit in the future.
  5. Collection Efforts: If you don’t pay after defaulting, the lender might:
    • Contact you directly to attempt to collect the debt.
    • Hire a debt collection agency to recover the money. These agencies can sometimes use persistent and aggressive tactics.
    • Sell the debt to a third-party collection agency, which will then seek to recover the debt from you.
  6. Legal Action: If collection efforts fail, the lender might decide to sue you to recover the debt. If they win the case, they could obtain a judgment against you, which might allow them to garnish your wages, levy your bank accounts, or place liens on your property, depending on jurisdictional laws.
  7. Loss of Collateral: If the loan is a secured loan, such as a mortgage, the lender might have the right to repossess or foreclose on the collateral (your house, car, etc.) to recoup their losses.
  8. Increased Loan Costs: Due to added late fees, higher interest rates, and potential legal fees, the total amount you owe can increase significantly after a default.

What to Do If You’re Going to Default on Your Loan

If you know you are going to default on your loan, be proactive about it. Contact your lender ahead of time and let me know about your situation and how you are struggling to make payments. Most lenders will work out a deal where you can keep the loan because it’s in the lenders best interest to do so. 

Make sure to document every conversation you have with the lender. Keep track of what is said, the dates the conversations were had, and keep your own records of agreements to hold lenders accountable as well. You can use this information to help build your case if there are loan payment disputes in the future.

Remember, most lenders want to work with you to find a solution.

Here are the steps you should follow if you believe you’re going to default on your loan:

  1. Contact Your Lender: As soon as you recognize that you might have trouble making payments, reach out to your lender. Many lenders prefer to work out a solution rather than go through the time-consuming and costly process of collections or legal action.
  2. Understand Your Loan Agreement: Familiarize yourself with the terms and conditions of your loan. This will give you an idea of any penalties, increased interest rates, or other consequences associated with missed payments.
  3. Request a Modified Payment Plan: Some lenders may be willing to modify your payment plan temporarily or even permanently, depending on the circumstances. This could include:
    • Extending the loan term.
    • Reducing the interest rate.
    • Offering a temporary payment deferral.
  4. Seek Financial Counseling: Consider consulting with a financial counselor or credit counseling agency. They can provide guidance on budgeting, debt management, and might even negotiate with lenders on your behalf.
  5. Consider Refinancing or Loan Consolidation: If you have good credit, you might be able to refinance the loan to obtain a lower interest rate or better terms. If you have multiple debts, consolidation might be an option to simplify payments and potentially reduce interest costs.
  6. Prioritize Your Debts: If you have several loans or credit lines, decide which ones are most crucial to pay first. Typically, it’s best to prioritize secured debts like mortgages or auto loans, as defaulting on these can result in the loss of essential assets.

Prevent Defaulting on Your Loan

Don’t wait until it’s too late and bridges are burned. Our experts at Yieldi are more than happy to walk you through the process so we can come to a solution together. Schedule an appointment or contact us online today!