Defaulting on a Loan: What it Means and How to Avoid It

what does it mean to default on a loan

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What does it mean to default on a loan? Well, let me paint a picture for you: you might think you have an excellent repayment plan for your loans; an excellent job and perhaps a clean bill of health.

Nothing will come between you and your loan repayment. But life has a way of kicking us down when we least expect it, and before you realize it, you can longer afford to repay your loan.

Maybe you got canned at your place of work just when you thought things were getting better. Perhaps you or a loved one got ill, and the insurance cover is not enough to foot the bills. Or maybe you forgot about repaying your loan.

The reasons could be endless. However, once you miss a payment when it is due, then it becomes delinquency. Extended delinquency is what leads to loan default.

So, to answer your question what does defaulting on a loan means; it is the failure to repay your loan as per the agreed terms with the lender. The consequences have a more significant impact on your life.

Consequences of Loan Default

There are different types of loans that are advanced to individuals, which translates to various consequences. The most to be affected though, in any scenario, will be your credit rating and your expenses.

Your expenses will increase the minute you default on your loan- from paying penalties to late repayment fees and legal fees.

Expect your credit score to be impacted, and not in a positive way. Most lenders report missed payments, especially after the grace period has lapsed to credit bureaus.

This will lower your credit score, which in turn makes it hard for you to access credit in the future. Not just obtaining credit in the future, but you might have a hard time getting a job, renting, securing insurance and even paying for utilities and mobile services.

If not repaid, defaulted loans are then forwarded to debt collectors for collection purposes. You do not want to find yourself here, as you will have legal fees to settle and have your wages garnished.

Bottom line is avoiding defaulting on your loans as much as possible. If by any chance you foresee a failure to meeting the agreed payments with the lender, talk to your lender and come up with a payment plan that suits you both.

This is what happens to different loan types upon default:-

1. Student Loans

Student loans might offer you many repayment options and a chance to defer payment or apply for forbearance, but you lose these options upon default. A default on your student loan will lead to:

  • Having your wages trimmed by the Department of Education. Other debtors might also sue for the right to have your wages garnished. In such a case, you will bear the collectors legal fees.
  • Having your tax refunds and other federal benefits withheld.

Other than that, your credit score will also be negatively affected, and it will take years for you to rebuild it. You will also not be eligible for more federal student loans in the future. The loan default will also stay on your record for life, whether you file for bankruptcy or not.

You, however, can avoid all this. First, student loans have a grace period of 270 days. That is long enough for you to know whether you can make the repayments as agreed with the lender. If not, contact your lender for a repayment plan that suits your current situation.

Another option is to have your student loans consolidated and refinanced. This way, you can get a loan under one lender, with new repayment period and possibly, a lower interest rate. To get you started, Super Money and Purefy are some of the companies to consider for student loan consolidation and refinancing.

Learn more on student loans refinancing before deciding.

2. Credit Card Loans

While swiping your numerous credit cards at retail stores is fun, repaying the loans and the interest might not be, especially when you are not well-off financially. Once you miss a payment 180 days after your last payment, you will be considered a defaulter.

Your credit score will, of course, plummet for the worst- not forgetting the additional late payment fees, accrued interests, and penalty fees. This will make your outstanding debt with the lender much higher.

The lender might also send debt collectors your way or sue for your wages to be garnished. A chat with your lender before it gets this far might save you though.

Get in touch as soon as possible, let your lender know of your situation and have a new payment plan that you can keep up with.

Alternatively, have your credit card loans consolidated and refinanced by firms like Upstart.

3. Auto Loans

With most lenders, repossessing the car will be the options albeit not the best. For starters, vehicles depreciate over time. This means that the current value of the car might not be enough to cover the remaining loan balance.

Once repossessed, most lenders will resell it to recoup their money, which might not be enough if the value of the car has gone down,

Some lenders might prefer a new repayment schedule- one that you can afford and will have you keeping your car.

4. Mortgage

When you take a mortgage, your house will be the collateral. What that means is that in case of default, the lender has the right to seize the house, which leads to foreclosure.

You do not want to be out in the streets or looking for a cheaper place that you can afford for missing out payments of your mortgage. One way to avoid this is by refinancing your mortgage. FHA is a great place to start, and they offer a number of refinancing options.

Mortgage lenders are like the rest, we have discussed. You need to be in communication with your lender when you know you cannot make your payments. If your payment history outstanding, the lender might give you a new repayment schedule you can afford. You will also get to keep your house.

5. Secured and Unsecured Loans

Business loans and personal loans, too do have consequences when one defaults on payment. Mostly, it will depend on whether the loan is secured or unsecured. A secured loan means it is backed by security such as a deed or a car among others. When you default on a secured loan, the lender can seize the security and sell it to recover the money owed.

Unsecured loans, on the other hand, are not backed by any security. While the lender has no property to take from you and sell, they can forward your name to credit bureaus for listing. This will affect your credit score. Worse still, they can sue you for failing to meet the agreed terms.

In conclusion, defaulting on a loan is highly likely, with dire consequences. However, one can avoid getting into that loan defaulter list. Communicate with your lender soonest possible, so you all are on the same page.

It will get you a new repayment schedule and keep the lender from forwarding your name to credit bureaus or sending debt collectors your way.

You can also consolidate and refinance your loans, whether it is student loans, credit card loans or a mortgage.

When it all hits the roof, these debt settlement companies might come in handy.

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