Defaulting on a loan happens when you miss payments for a specified period of time. When a loan defaults, it’s sent to a debt collection agency whose job is to collect the unpaid funds from you.
A loan default can drastically reduce your credit score, impact your future eligibility for credit and even lead to the lender seizing your personal property. If you struggle to make regular payments, contact your loan servicer to discuss options, such as creating a manageable payment plan.
Loan Default Explained
A default on debt happens when a borrower fails to repay the funds according to the initial agreement. With most consumer loans, this typically involves missing multiple payments for several weeks or months in a row.
Fortunately, lenders usually allow a grace period before penalizing the borrower after missing one payment. The period between missing a loan payment and having the loan default is known as "delinquency." The delinquency period helps you avoid default by giving you extra time to contact your loan servicer and catch up on missed payments.
Below are examples of what happens when you default on a loan or credit card. Keep in mind that exact timelines vary from lender to lender, so only use the following as a rough guide.
Typical time until default (after last payment)
Typical grace period (before reported to credit bureaus)
|1 to 90 days
Defaulting on a loan of any type can result in severe consequences. If you’ve missed one or more payments or your loan is currently in delinquency, contact your loan provider immediately. Often, lenders will work with you to create a payment plan that works for both parties.
It’s essential to avoid having loans in default as it can lead to the seizure of assets or wages and seriously damage your credit score.
How Loan Default Works
Defaulting on a loan will cause a substantial drop in your credit score, potentially resulting in higher interest rates on future loans. If you default on a loan secured with collateral, the bank may seize your pledged assets. Mortgages, auto loans and secured loans are the most popular forms of consumer debt backed by collateral.
The consequences of default can vary in severity for unsecured debts like credit cards and student loans. In extreme cases, debt collection agencies can garnish wages (take money directly from your earnings) to pay back the outstanding debt.
Here are the most common scenarios for the following types of loan default:
Consequences of default
|Possible lawsuit and wage garnishment
|Secured Personal or Business Loan
|Unsecured Personal or Business Loan
|Lawsuit and revenue or wage garnishment
For federal student loans in default, the first consequence is "acceleration" — this is where the loan’s outstanding balance is due immediately. The government can withhold your tax refunds and federal benefits until you fully repay this debt. Debt collectors can even take you to court to seize your wages, leaving you to also cover court costs and other legal fees.
As with most debt obligations, defaulting on a student loan can cause your credit score to plummet. It can take years to recover from such a hit, especially since a student loan default remains on your credit report for seven years. Additionally, borrowers who default might not be able to apply for federal student aid, income-driven repayment plans, loan deferment or forbearance.
The good news is that federal student loans have a long delinquency period — 270 days, or roughly nine months before they default. This allows proactive borrowers to get their finances in order, thus avoiding default altogether.
For borrowers with a delinquent loan, try to stay in contact with your loan servicer and explain your financial situation to them.
While most credit card companies typically allow one late payment before penalizing card holders, missing multiple bills can ding a credit score by as much as 180 points. Additionally, card companies can add a late fee (typically $15 to $35), along with a penalty interest rate.
A credit card default can trigger an aggressive debt collection process where a debt collection agency contacts you frequently. However, while collectors can sue and possibly win a wage garnishment, they’re generally more willing to negotiate a partial debt repayment.
The typical delinquency period before credit card debt defaults is around six months. While this gives debtors sufficient time to fix their finances, it also allows the unpaid debt to accrue interest rapidly. If you want to avoid this situation, consider taking out a personal loan to consolidate your outstanding debt. Personal loans offer fixed monthly payments and generally have lower interest rates than credit cards.
Since mortgages use the purchased home as collateral, the bank can seize the home if you fail to stick to the initial payment agreement. For most homeowners, defaulting on a mortgage leads to foreclosure.
While this is a drastic consequence, you can avoid foreclosure by refinancing your mortgage to make it more affordable. Eligible homeowners might consider the Home Affordable Refinance Program (HARP), which is designed to help underwater borrowers.
Above all, making timely payments can help you avoid default. Like with other loans, it's important to communicate with your loan servicer if you can’t make your mortgage payment. If you've made consistent payments in the past and can prove your current financial distress, you may be able to negotiate for a restructured loan agreement.
When an auto loan defaults, the lender or car dealer can usually seize or repossess the car to pay the outstanding debt. However, most auto lenders use repossession as a last resort. Since the value of a vehicle depreciates over time, the current worth of a repossessed car probably won’t cover your outstanding balance.
Additionally, the lender must sell the repossessed car to get any cash. Because of this, lenders prefer to get money directly from their borrowers rather than seize collateral. In the end, it’s worth working with your lender to restructure the terms of an auto loan if you can’t manage the regular payment.
Other Types of Loans
For personal and business loans, the consequences of default can vary depending on whether the loan is secured or unsecured. With business loans, defaulting will likely have a negative impact on the business owner's credit score if a personal guarantee backed the loan.
Defaulting on a personal loan may also limit your options to receive credit in the future. As outlined above, you can avoid such defaults by negotiating with your lender for a restructured loan.
Here’s what you might expect when your loan goes into default:
- For secured personal loans: The default will usually result in the lender seizing the collateral asset.
- For secured business loans: The default will usually result in lenders capturing revenue or inventory.
- For unsecured personal loans: The default will often result in wage garnishment.
- For unsecured business loans: Lenders can litigate to receive a lien against a company's earnings.
How to get out of loan default
For student loans, specific programs like loan consolidation and loan rehabilitation are designed to get you out of default. Rehabilitating a student loan allows borrowers to make a monthly payment equal to 15% of their monthly disposable income. To qualify for this, however, borrowers must first make nine consecutive payments.
Loan consolidation, the other federal student loan program, allows a borrower to get out of default by making three consecutive monthly payments at the initial price, then enrolling into an income-driven repayment plan. Because declaring bankruptcy doesn’t always erase student loans, these programs allow lenders to recoup their losses.
It’s much harder to find specific programs or loans designed to help you get out of default for other types of loans. Your best bet is to negotiate a repayment plan with your debt collector whenever possible.
Depending on the size of your defaulted loan and the severity of your debt, you might also consider hiring a bankruptcy lawyer to examine your financial situation. If you're too overwhelmed with outstanding debts, you could likely benefit from the loan forgiveness provided by declaring bankruptcy.