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. 

What is loan default?

Loan default is when a borrower fails to meet the terms of their loan agreement. When a borrower falls behind on payments, the loan may go into default. One late or missed payment won’t result in an immediate loan default. In most cases, you must miss payments for an extended period for your loan account to go into default. 

What happens when a loan goes into default?

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, you may experience the following:

Missed payments and late fees

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

Many installment loans (such as 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” isn't a payment grace period. It’s the period of time between the day your billing cycle ends and the day your payment is due. On most credit card accounts, if you pay off your purchases during the grace period, 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 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 (some states impose limits). 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.

Credit score damage and financial impact

After 30 days, your missed payment could be reported to the credit bureaus. You're now officially delinquent (late) on your loan. Your credit standing could suffer. Payment history is the most important factor in your credit score. It’s best to get caught back up on payments right away. 

Penalty interest rates

Some 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. 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 typically considered in default. Lenders use different timetables 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 30-90 days overdue

• Federal student loans: 270 days

Even if you’re current on your payments, a mortgage could be considered in default if you violate other terms of your loan agreement. For example, if you fail to pay your property taxes or carry homeowners insurance.

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

Debt collection efforts and legal actions

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 can be risky. The creditor’s logical (and possibly only) next move would be to file a debt lawsuit against you. 

Debt collectors can sue you for the outstanding balance. If they win, they can ask the judge to let them take money from your bank accounts or force you to surrender property. 

Loss of assets or wage garnishment 

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 if you can’t get caught up on payments. This is called voluntary surrender, and might save you some money by lowering the creditor’s collection costs. 

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

If you default on your mortgage, your lender can 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. 

If they win a lawsuit, debt collectors can ask the judge for permission to garnish your wages (force your employer to send part of your wages to the court and on to your creditors). If you’re sued by a credit card company or debt collector, don’t ignore it. 

Is defaulting on a loan a crime?

No, defaulting on a loan due to financial hardship isn't 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.

How does defaulting on a loan impact your credit?

If you default on a loan or debt, your credit will suffer if the lender reports your account. A default can remain on your credit report for up to seven years. Having a default in your file is likely to make it harder to qualify for mortgages, personal loans, or traditional credit cards in the future, at least for the first few years. The effect of all negative items on your credit reports lessens over time.

What are your options if you’re at risk of default?

Default is a serious situation that you should try to avoid. Often, you can work out a solution with your lender to avoid default. 

On a mortgage, for example, if you miss two payments in a row, the law requires the lender to contact you about your options for avoiding default. These may include:

• Forbearance (the lender allows you to skip a number of payments)

• Loan modification (the lender changes the terms of your loan to make it more affordable)

• A short sale (the lender allows you to sell the home for less than the amount you owe)

Debt negotiation

It’s possible to negotiate with your creditors to accept less than the full amount you owe and forgive the rest. Sometimes creditors are willing to offer debt relief if it’s clear that you have a hardship.

If other concessions might help you, ask your creditor to reduce your payments, mark your account current so you don’t have to catch up, or let you skip a certain number of payments. 

When you’re experiencing financial hardship, you can ask your creditors or lenders if they offer a debt hardship program. For example, credit card hardship programs may temporarily reduce your minimum credit card payments or pause payments for a short time. 

Avoid default if it hasn’t happened yet by managing your debt

Here are some helpful tips:

• Set up automatic payments or reminders. If you sometimes forget to make payments, use free tools to ensure you always pay your bills on time every month.

• 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. Following a budget can help you manage your money so you can afford to make your agreed-upon payments. Adjust your budget when needed. If your budget is tight, look for ways to increase your income, or do a spending freeze for a few weeks to make sure you have enough money to cover necessities.

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(s). They may be able to restructure your loan or let you skip a few payments. Alternatively, other options may be available. Here are some actionable steps you can take to recover from loan default: 

Get support: how credit counseling could help you

Credit counselors can help you enroll in a debt management plan, or DMP, for your unsecured debts. They may be able to negotiate with your creditors to get more favorable terms such as a lower interest rate. You’ll be required to close your credit accounts and avoid opening new ones while you’re in the plan. You could learn better debt management, budgeting, and spending habits. 

Unlike most debt consolidation loans, you might qualify for a DMP even if you’re in default. However, DMPs are designed to fully clear your balances in five years or fewer, with no debt forgiveness. 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. 

Debt relief is when the creditor agrees to close out your debt for less than what 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 to  recover at least part of what they are owed.

DIY debt negotiation is possible. However, it can be intimidating, especially if you’re dealing with multiple accounts. Professional debt resolution specialists could make the process easier.

Read more: Why choose Achieve Relief?

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.