What does it mean to default on a loan?

Receiving an intimidating default notice in your mailbox can be downright scary, but it’s not hopeless. First, understand that default notices are designed to stress you out and get you to act. But stress isn’t helpful if you can’t afford to pay your debt. What's helpful is understanding what it means to default on a loan—and what your options are. Because you do have options, and you can get through this. 

Is defaulting on a loan a crime?

No, defaulting on a loan due to financial hardship is not a crime. You can’t be arrested for simply failing to repay a loan. 

Defaulting typically results in financial consequences like credit score damage and collection efforts. It could also lead to lawsuits. Defaulting on a loan could lead to criminal charges if it involves fraud, such as providing false information on your loan application or intentionally swindling a lender. 

What does loan default really mean?

Loan default means you have stopped making payments on a debt that you owe. Defaulting on a debt doesn’t happen overnight. It’s just one step in a predictable process. If you’re overwhelmed by debt, some of this may feel familiar.

Late payment

Your payment is technically late if you make it after 5:00pm on the day it’s due. However, most lenders give you a grace period before your payment is officially considered late. 

Many installment loans (mortgages, home equity loans, personal loans) give a 15-day grace period. After the grace period passes, you may be charged a late fee. Even so, your payment will be reported as “on time” to credit bureaus as long as it’s fewer than 30 days late. 

With credit cards, a late fee usually kicks in on the first day after the payment due date. But just like loan payments, a late payment on credit card debt typically won’t be reported to the credit bureaus as late until it’s 30 days late.

Achieve tip: A “credit card grace period” is not a payment grace period. It’s the period of time between the day your billing cycle ends and the day your payment is due. If you pay off your balance during this time, you won’t be charged interest. Not all credit cards have a grace period, and not all transactions are interest-free during the grace period.

If you miss two mortgage payments in a row, the law requires the lender to contact you about your options for saving your mortgage. These may include forbearance, loan modification, or a short sale. 

Credit score damage

After 30 days, your missed payment may be reported to credit bureaus, causing your credit score to drop. You're now officially delinquent (late) on your loan. Your credit standing is all but guaranteed to suffer. Payment history is the most important ingredient in your credit score. 

Late fees

If you pay after your grace period expires, you’ll probably be hit with a late fee. 

• For credit cards, the maximum allowable late fee is $41.

• For personal loans, auto loans, and mortgages, there's no federal law that limits late fees. It could be $25 to $100, or 3% to 5% of the missed payment amount. The late fee should be in your original loan contract, and may also be mentioned on your monthly statements.

Penalty rates

Most credit card issuers impose a higher interest rate on your entire balance, called a penalty rate, if you pay 60 days late. Other things can trigger the penalty rate, such as your payment being returned. If you don’t get your payments back on track, they can charge you the higher rate indefinitely. Even if you do resume on-time payments, the issuer can keep charging you the higher rate for new purchases in the future. 

Default status

After several missed payments, your account is in default. Lenders use different time tables for putting accounts into default status. These timelines vary from one lender to the next, but here are some general guidelines:

• Credit card companies: 180 days past-due

• Personal loan providers: 90 days past-due

• Auto lenders: As soon as one day late but typically 90 days overdue

• Mortgage lenders: 120 days (four missed payments).

Default status triggers a number of actions, depending on the lender. Credit card issuers, for instance, will probably close your account.

Collection efforts

Once you officially miss a payment, your lenders will likely try to reach you through the mail, online, and by phone. The farther behind you fall, the more your creditors will step up collection efforts.

Once your credit card account is in default, the issuer may charge off the balance and sell it to a debt buyer or turn it over to a collection agency. Expect to be contacted by phone, mail, email, text, and/or social media. Debt collectors may also contact your family if they can’t locate you. 

You can make debt collectors leave you alone by sending a cease and desist letter. However, cutting off contact completely could cause the debt collector to file a lawsuit. 

Loss of property

If you default on a secured debt, like a mortgage or auto loan, you could lose your home or your car. The lender doesn't usually have to sue you to repossess property that secures a loan. 

You could choose to turn in a vehicle. This is called voluntary surrender, and may save you some money by lowering the creditor’s collection costs. You might be able to buy back the vehicle or reinstate your loan later.

Vehicle repossessions and voluntary surrenders stay on your credit report for up to seven years. 

If you default on your mortgage, your lender will probably begin foreclosure. The cost of foreclosing will be added to your balance. You could continue to live in the home, but it may be put up for sale and announced to the public. 

Lawsuits

Debt collectors can sue you for past-due amounts. If they win, they can ask the judge to let them take money from your bank accounts or force you to surrender property. They could also ask for permission to garnish your wages (force your employer to send part of your wages to the court and on to your creditors).

Dodging default: how to keep your finances afloat

Default is a serious situation that you should try to avoid. Often, you can by staying in contact with the lender and working out a solution together. It’s possible to negotiate with your creditors. For instance, your creditor may be willing to reduce your payments, mark your account current so you don’t have to catch up, or allow you to skip a certain number of payments. 

The best way to avoid default is to manage your debt. 

• Set up automatic payments or reminders.

• Contact your creditor right away if you can’t afford your payment. Ask for forbearance or to make a smaller payment. Don’t just send a partial payment without an agreement in place.

• Create and stick to a budget so you can make the payments you agreed to. Adjust your budget when needed. 

If default happens: how to recover

If default happens despite your best efforts, take a minute. Don’t panic. There are solutions to debt you can’t afford, and you’ll find one. 

Your first move should be to take a deep breath and contact your lender. They may be able to restructure your loan or let you skip a few payments. 

Get support: how credit counseling could help you

Credit counselors can help you get on top of unsecured debt like credit card balances, personal loans, and medical debt. You could learn better debt management, budgeting and spending habits. 

Credit counseling agencies may also help you consolidate your unsecured accounts into a debt management plan, or DMP. And they may be able to negotiate more affordable terms from your creditors. Unlike most debt consolidation loans, you may qualify for a DMP even if you’re in default. However, DMPs must fully clear your balances in five years or fewer. That could make the plan's payments unaffordable and cause you to drop out—and many people do. 

Negotiate your debt to get rid of it faster

If you’re ‌dogged by default, you might be able to negotiate your debt to an affordable level and get rid of it faster. If the idea of negotiating your own debts feels overwhelming or unappealing, you could work with a professional debt resolution company that specializes in negotiating with creditors.

Debt resolution is when the creditor agrees to close out your debt for less than the full amount you owe. Why would your creditor take less than it’s entitled to? Because if you’re defaulting or close to defaulting, it’s obvious that you can’t afford your debts. There’s a chance the creditor may get nothing. If you have a financial hardship that has made your debts unaffordable, many creditors are willing to be flexible so that they can recover at least part of what they are owed.

Debt negotiation can be intimidating and complicated, especially if you’re dealing with multiple accounts. Professional debt resolution specialists could make the process easier if you choose to go that route. 

Read more: Why choose Achieve Resolution?

What’s next 

If you’re in or close to default, take action:

• Contact your creditors and ask for help.

• Compare your options: catching up, surrendering property, credit counseling, and debt negotiation.

• Get professional help if you need it.

The worst thing you can do is ignore the problem. Talk to a debt expert who can help you figure out what solution is best for your situation.