When you take out a loan for a car, house, or any other type of personal loan, you promise the financial institution to repay the money according to the terms of the loan. A loan is in default if the borrower stops making payments on the loan. Defaulting on a loan can hurt your credit score, making it harder to get loans or better rates in the future.
What is a payment default?
What does it mean to default on a loan? A borrower is in default when he stops repaying his loan. For most loans, this means the borrower failed to make multiple consecutive payments, violating the terms of the agreement. When a loan is considered in default depends on the type and terms of the loan.
Defaults can happen with any loan, such as a mortgage, car loan, credit card, or personal loan. Lenders will consider the loan to be in default if the required minimum payment is not paid for a certain period of time specified in the agreement. The time period is usually one to nine months, depending on the type of loan. So, if a borrower fails to make their car payments for several consecutive months, then they are in default.
What happens if you are in default?
When a loan is in default, most lenders require the borrower to immediately pay the full amount of the loan plus interest. Depending on the type of loan, the lender may seize any collateral collateral or you may be taken to court and have your wages garnished. If there is a trial, any judgment against you may be made public.
Payment history accounts for 35% of your credit score, so defaulting on a loan will have serious consequences. A default will stay on your credit report for up to seven years. This may impact your ability to obtain future mortgages, auto loans, and credit cards. If you qualify, your interest rate will likely be very high. A low credit score can also hurt your chances of getting insurance, utilities, or permission to rent an apartment. Many employers also perform credit checks before hiring an employee.
On top of that, the lender or collection agencies will keep calling and demanding payment from borrowers who have defaulted on their loans. They will continue to pressure you until the debt is paid off or threaten to take legal action.
Default on a secured loan
A secured loan is secured by collateral such as a car or house. Default on a secured loan means that the lender will seize the collateral to repay the loan. If you default on an auto loan, the lender will repossess the car. In the case of a house, they will seize it.
The financial institution would then try to sell the asset to recoup its losses. If the collateral isn’t enough to repay the loan, the lender may try to collect the remaining balance from you. In the rare case where the collateral is worth more than the loan, the lender may give you the excess. Either way, defaulting on a loan will hurt your credit score.
The most common types of secured loans are:
- Automatic loan
- Secured personal loan
- Secured business loan
Default on an unsecured loan
An unsecured loan is not asset backed but is backed by the borrower. Lenders will attempt to collect the remaining loan payments. If they are unable to do this, they usually send your loan to a collection service. In some cases, they may sue and attempt to garnish wages or put a lien on any property you may have.
The most common types of unsecured loans are:
- Credit card
- Unsecured personal loan
- Unsecured business loan
What is the difference between default and delinquency?
A loan is past due if you have missed a payment but have not yet defaulted on the loan. Delinquency begins on the first day after the due date. The loan then becomes delinquent or delinquent. The delinquency period can last from one to six months, depending on the terms of the loan.
Borrowers will generally be charged a penalty fee and the lender will contact the borrower to collect payment. If the borrower makes payment, the loan will be considered in good standing. If the lender has been unable to collect the loan payment while it is past due, then the loan will be considered in default.
Lenders will usually contact the credit bureaus to report a delinquent loan. The lender will send notifications to the borrower to let them know that the loan is in default. If the lender is unable to do so, they will sell the debt to a collection agency and the collection agency will send notices regarding the loan.
What is a grace period?
Some lenders will grant a grace period if a payment is late. A grace period gives the borrower a short period of time to repay the loan after the due date. There are no penalties incurred during this period. However, the loan will continue to earn interest. Here are typical grace periods for different types of loans. Remember that the grace period varies depending on the terms of your loan and yours may be different.