If you’re behind on paying off your debts or are in financial difficulty, a default can be a frightening possibility on the horizon.
The consumer loan default rate reached record highs in 2020 and 2021, despite the widespread economic downturn. This counterintuitive phenomenon was partly due to the government’s COVID-19 relief initiatives, such as stimulus payments and improved unemployment benefits.
But, as those initiatives wind down, banks are seeing borrower defaults slowly rebound from pandemic lows. For example, Wells Fargo has started to see “very, very small increases in delinquencies,” CEO Charles Scharf said at the Goldman Sachs US Financial Services Conference in December 2021..
Defaulting on a loan can have a serious negative impact on your financial life, from dropping your credit score to losing your home or car, to lawsuits and even garnishment. of salary. But if you take steps now to reach an agreement with your lender, you may be able to get your debt under control and avoid the worst consequences of default.
Here’s what you need to know.
What does it mean to default on a loan?
A default means that you have not made payments according to your loan agreement and the lender believes that you have no intention of making further payments. Unlike a default, which can occur after a single late or missed payment, a default is much more serious and fundamentally changes the nature of your loan.
Most lenders will start reporting missing payments to credit bureaus after 30 days, says Amy Lins, vice president of corporate learning at Money Management International, a nonprofit credit counseling agency based in Sugar Land. , in Texas. If you continue to miss payments, your lender will consider the loan delinquent. For private loans like personal loans or private student loans, it’s up to the creditor to determine how long it can take before the loan is considered past due or in default, Lins says.
Failure to pay can have serious consequences on your credit score and finances. For this reason, if you are currently in default or cannot repay a loan, it is best to contact your lender to discuss other options instead of leaving your loan in default.
How Default Works
Although default and delinquency are sometimes used interchangeably, the two terms mean different things. As soon as you miss or are late on a payment, your loan is considered delinquent, says April Lewis-Parks, director of corporate communications at national nonprofit credit counseling organization Consolidated Credit. Depending on the terms of your loan agreement, failure to pay may result in late fees or other penalties, but it generally won’t affect your credit score as long as you’re no more than 30 days past due. a payment.
If you are behind on loan repayments due to financial hardship, contact your lender directly as soon as possible to try to work out a deal before your loans go into default.
Once you have been in arrears for a period of time, your loan will be in default and your lender will begin to take action to recover that money. It’s ultimately up to the creditor how they handle their bad debt, Lins says. They may try to contact you through their own internal collections team or work with a third-party collection agency. As a last resort, they can sell it at a discount to a debt collection agency, who would then own the debt and can try to collect it from you.
Depending on the specific type of loan, the lender may also take other actions after a loan has gone into default. Here are some examples :
Car credits: Auto loans are secured by your vehicle, which means that if you don’t make payments, your lender will repossess your car and try to sell it to recoup their losses. If the resale value of the car doesn’t cover the outstanding amount, lenders also have the option of taking legal action and obtaining judgment against you for the difference, Lins says. For example, if you owed $17,000 on a delinquent car loan and the lender was only able to sell the car for $15,000, they could sue to get the remaining $2,000 from you.
Mortgages: Since your mortgage is secured by your home, which serves as collateral, failure to pay your loan will result in your property being seized by the lender through a process known as foreclosure. The exact foreclosure process will vary depending on the laws in your state. Some states require a court foreclosure, which requires the lender to seek judgment from the courts, while other states allow non-court foreclosures, which does not require the lender to go to court and can therefore proceed much faster .
Student loans: When private student loans are in default, they are generally treated the same as personal loans and credit cards. But federal student loans follow a different process. Once 30 days have passed since your last payment, a federal loan is considered past due. When it reaches the 270 day mark, it is considered defaulted. Student loans are unique in that the federal government can garnish your wages without needing a court order if you are in default, while most other types of debt require a creditor to bring you first. in justice.
What are the penalties or consequences of non-payment?
Depending on the type of loan you default on, you could face serious consequences ranging from a damaged credit rating to seizure of assets to possible legal action. Here are some of the most common consequences of defaulting on payment:
- Damaged credit score: No matter what type of loan you default on, you will almost certainly see a serious and lasting negative impact on your credit score. Your payment history makes up 35% of your credit score, and a default can stay on your credit report for up to seven years. This could make it harder to get new credit in the future.
- Seizure of assets: If you default on a secured loan – a loan secured by collateral – the lender can seize the asset you used as collateral and sell it to recoup the cost. Common secured loans include mortgages, which use your home as collateral, and car loans, which use your vehicle as collateral. Home equity loans and HELOCs are also secured loans secured by your home. Some personal loans may also be secured, with the exact collateral required varying by lender. Losing your home or car can turn your life upside down, so it’s especially important to avoid leaving secured loans in default if you can.
- A legal action: If you are in default, your creditor could sue you to recover the amount owed. The exact process depends on your state’s laws, but if your creditor can get a court order, they may be able to recover your personal assets or garnish your wages.
- Payday entry : While most types of debt require a creditor to obtain a court order before they can garnish your wages, federal student loans are different. If you fail to repay a federal student loan, the federal government can seize up to 15% of your disposable income to pay your debt without taking you to court. The government can also do cash compensation, Lins says, where it takes money from your tax refund or Social Security benefits to pay your debt.
How to get out of the fault
1. Contact your lender
If you anticipate not being able to meet your loan repayments, contact your lender as soon as possible. Explain your situation and see if you can negotiate a payment plan to get you back on track. Most lenders prefer to work with you to find a solution before you go into default, rather than going through the expense and hassle of collections.
Especially in today’s environment, “lenders are really willing to work with people,” says Lewis-Parks. “So [consumers] shouldn’t be afraid to reach out. It will never make the situation worse. »
If you’re behind on your mortgage, talk to your lender about options to avoid foreclosure. You may be able to enter into a forbearance agreement, in which the lender allows you to reduce or suspend payments for a period of time. Or, you could work out a loan modification, where the lender adjusts the terms of the loan to lower your monthly payment.
2. Rehabilitate or consolidate your federal student loans
There are two main ways to get out of federal student loan default: rehabilitation and consolidation.
As part of the rehab, you will work out a new repayment plan with your loan provider based on your discretionary income. After nine one-time monthly payments under a rehabilitation agreement, your loan will no longer be in default and the default record will be removed from your credit file.
Loan consolidation allows you to consolidate your defaulted federal loans into a new direct consolidation loan and repay the new loan under an income-driven repayment plan.
A third, less common option is to pay off your defaulted loan in full. This probably won’t be feasible for most borrowers, but it could be an option if you’ve already defaulted on your loan, but have since received a sudden windfall and now have the funds to pay it off completely.
3. Ask for help if you need it
If you feel overwhelmed with debt or don’t know where to start, consider seeking help from a nonprofit housing or credit counseling agency. A professional counselor can advise you on your options, help you strategically prioritize your debt, and help you negotiate with your creditors or develop a debt management plan.
“One of the things we really do is help [consumers] break that cycle of inaction, understand what their choices are, help them come up with a plan and move forward,” Lins says.
Some credit counseling agencies may charge a small fee for their services, but these can usually be waived if you are in financial difficulty.
A housing counseling agency offers advice specifically related to housing – including mortgage default and foreclosure – while a credit counseling agency can offer help with several types of debt, from credit cards personal loans to student loans.