Key takeaways

  • Defaulting on a loan can result in late fees, debt collection and potential legal action from the lender.
  • It is important to consider your budget and potential future expenses before taking out a loan to avoid defaulting.

  • If you find yourself in default, options such as debt consolidation loans and credit counseling can help you get back on track.

Loan default happens when you regularly miss your monthly loan payments for an extended period of time. Depending on the loan type, this can be anywhere from one day to 270 days since the last payment. When this happens, your loan will get sent to a debt collection agency to recover the unpaid loan balance.

Defaulting on a loan can cause long lasting damage to your credit score, pile on late fees, and in some cases, can result in getting sued by your lender or having your property or assets seized. Thankfully, there are ways to avoid loan default, especially if you act quickly.

Consequences of defaulting on an installment loan

Defaulting on an installment loan often leads to lasting negative ramifications on your financial health, especially when it comes to your credit score.

While there are a number of potential outcomes that could happen to borrowers in the case of default, the consequences ultimately rely on the lender’s decision, the type of loan or line of credit you’ve taken out and any hardship payment relief options.

Credit damage

If your monthly payments are more than 30 days late, the lender may report the delinquent balance to the credit bureaus, which will drop your credit score by a few points.

Most lenders will use your FICO score when looking at your credit health, and 35 percent of the score comprises your payment history. Therefore, routinely missing the monthly payments could very well have a negative impact on your credit score.

What’s more, late or missed payments will appear on your credit report, giving lenders and banks a holistic view of your credit health and history. When determining eligibility for products such as mortgages, auto loans and personal loans, lenders look at your credit report. A negative repayment history will remain on your report for seven years and can reduce your approval eligibility for future loans. Or, if you do get approved, you’re more likely to be offered a much higher interest rate than if you had a positive repayment history.

Late payment fees

Most lenders – not all – charge late payment fees for delinquent payments. This fee can fall somewhere between $20 and $40; although, a $39 late fee is most common.

Depending on the loan type, your lender may offer a grace period. This is a set period of time – typically around 10 days – in which you’ll receive no negative ramifications for a late payment. To avoid a potential late fee, check to see if your lender offers a grace period and make the payment within the set timeline if possible.

If you have a positive repayment history, have never missed a payment over a series of years or have an existing relationship with the institution, it doesn’t hurt to call and ask if they can waive your late fee. While this isn’t an option with most lenders, some may have a one-time waiver or offer a similar perk for existing customers.

Debt collection

If your debt is outstanding for a long period of time, the lender may send the balance to a debt collection agency. This can result in regular phone calls, letters and emails from the agency in an attempt to collect the debt.

Debt collection can be stressful, as the agency will likely contact you weekly, if not daily, about the overdue debt. Reputable companies must communicate that you have 30 days to dispute the debt in writing. If you fail to do so, the agency can continue to contact you. You may be able to negotiate a settlement or repayment plan for certain debts.

Keep in mind that harassment of any kind – like threatening jail time or police presence – is illegal due to the Fair Debt Collection Practices Act (FDCPA). If the debt collector engages in deceptive practices, like lying about who they are or how much is owed, you can report the company to government agencies or sue them for deceptive practices.

Potential court hearing

If all else fails, the lender may sue you for unpaid past debts that fell into collections. If this happens and you receive a court summons, knowing your rights as a consumer is important.

Debt collectors have a limited amount of time to file a lawsuit – known as the statute of limitations – and once this time has passed, collection agencies don’t have legal grounds to sue you for the delinquent balance.

The statute of limitations will vary by state but generally lasts three to six years. In some states, debt collectors may be unable to sue you past the statute of limitations, but they can still contact you. By this point, your credit score will have taken a massive hit. To avoid this, contact the agency, confirm your debt and discuss your repayment options as soon as you get the collections notice.

How to avoid defaulting on your loans

Avoiding loan default starts with your loan terms and agreement. Before signing on the dotted line, ensure your finances can handle the current and future monthly payments. Consider potential emergency expenses or medical bills – will you still be able to keep up with payments should something happen?

If you can’t answer that question confidently but need the funds, ask the lender or institution about extended repayment options or if it offers hardship payment relief. While relief options won’t pay down your debt, they may reduce the risk of default and can make your monthly payments more budget-friendly.

If you are in a sticky situation and cannot make the payments, contact your lender’s customer service department immediately. It’s always better to be up-front with the lender and communicate your situation as soon as possible to reduce your risk of default.

How to get out of loan default

There are a few alternatives that can help you get out of default and back on your feet if you’ve already received the default notice. Other than speaking to your lender about repayment options, you can also consider borrowing a debt consolidation loan, although this may be hard to secure after defaulting.

If your credit is solid, you have a rich history of positive repayments or you have a creditworthy co-signer, you may be able to combine your defaulted debt with other open accounts through a debt consolidation loan. This will take your loan out of default status. However, you’ll need to closely examine your budget to make sure you can afford the monthly payments on the new loan.

A common option is seeking a credit counselor to help you manage and pay down your debt. Credit counselors offer services to help consumers get back on track financially, and some organizations offer their assistance free of charge.

Frequently asked questions about loan default

  • Defaulting on a loan is not a crime. Lenders don’t have legal jurisdiction to arrest you for an overdue balance. However, defaulting on a loan will have serious financial implications. It can result in the lender seizing your property as collateral (if applicable) and can be considered a civil offense, meaning that the lender could sue you for the unpaid amount.

  • Depending on the lender, missing a payment past the grace period could result in an automatic late fee and a small drop in your credit score. It’s best to repay the delinquent amount as soon as possible, as long standing unpaid amounts will result in a drop in credit, possible wage garnishment and default.

  • Installment loans show up on your credit report in multiple ways. When you first apply for a loan, the lender will conduct a hard credit check, which will result in a drop in your credit score. The loan will also appear as an open credit account, and if you miss a payment, it will remain on your report for up to seven years.

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