When you take out a loan, you promise to repay that money plus interest. But what happens if you can't keep up with the payments?
Falling behind on payments for a personal loan, mortgage, student loan, or auto loan could lead to loan default. Default causes severe harm to your credit and your overall financial health. If you’re searching for a way out of default, you have options, such as consolidating your debt or working with a credit counseling company.
Defaulting on a loan
When you miss one or multiple loan payments, your lender may take action. It’s easy to confuse default with delinquency, which happens the day after you miss a loan payment. Usually, lenders give you at least 30 days to bring your account back to good standing before your loan goes into default.
Defaults occur on almost any type of consumer loan, including:
- Personal loans
- Mortgages
- Home equity loans and lines of credit
- Credit cards
- Student loans
- Auto loans
Whether the loan is secured or unsecured indicates the steps a lender will take if the loan goes into default. A secured loan is a loan backed by valuable collateral. Common examples are a mortgage, which uses your home as collateral, and an auto loan, which uses your car as collateral. If you default on either of these types of loans, the lender may proceed to claim the collateral — either by repossession (auto loan) or foreclosure (mortgage).
An unsecured loan relies on the borrower fully repaying the loan without collateral to back the agreement. Credit cards and many personal loans fall into this category. If you default on this type of loan, the loan may go into collections and the lender could attempt to sue you to recover the debt.
But whatever the loan type, once you default, it kick-starts a series of consequences that could follow you for years.
Related: Personal Loan vs. Auto Loan
Loan default consequences
Defaulting on a loan is detrimental to your credit and overall financial health. Most lenders follow a tight protocol to help recover their money once a loan enters default status. The protocol differs depending on the lender and the type of loan, but these are some of the outcomes a defaulted loan may result in:
- In-house debt collection attempts: The lender’s collections department attempts to contact you by phone, email, or mail to make payment arrangements.
- Charging off debt: After unsuccessful debt collection attempts, they may send your loan account to an external debt collector.
- Damage to your credit score: Your lender reports your late payment to the credit bureaus after 30 days, which knocks your score down significantly. After 90 days, your score suffers even more. If you had good to excellent credit, your score could drop by over 80 points and the mark will stay on your credit for up to seven years.
- Potential lawsuit: Your lender may sue you to collect the debt. A lawsuit could lead to additional fees, court-ordered payments, or wage garnishment.
- Fees: Late fees, legal fees, and collections fees add to the remaining balance of your loan as part of the default.
- Wage garnishment (unsecured loans): If you have a government-backed loan or your lender successfully sued you, payments for the loan could be taken directly from your paycheck until it’s repaid.
- Seizing collateral (secured loans): For loans backed by collateral, like mortgages, auto loans, and home equity loans, defaulting may cause your lender to seize the collateral through repossession or foreclosure.
To see what happens when you default on a loan, we’ll break it down by loan type.
Unsecured loans
Defaulting on unsecured debt could land you in hot water, with consequences ranging from fees and credit damage to getting sued and wage garnishment.
For example, after a personal loan payment is late by 90 days, the loan goes into default. The lender may try to recoup its loss with these actions:
- Collection attempts
- Charging off the loan
- Reporting missed payments to the credit bureaus
- Assessing extra fees
If that fails, it can sue you for nonpayment of the debt. If it wins, you could be court-ordered to make payments through wage garnishment.
Secured loans
Defaulting on a secured loan could result in having the loan collateral seized and resold by the lender. For example, after not paying your mortgage for 150 days, your home loan would typically hit default status. Your mortgage lender might follow some of the same actions for an unsecured loan, including:
- Collection attempts
- Reporting missed payments to the credit bureaus
- Assessing late fees
If those tactics don’t work to get you back on track, your mortgage lender could begin the process of foreclosing on your home.
How to get out of loan default
If you’re struggling to make loan payments, there are a few options that can aid in getting out of default.
Contact your lender
Proactively reaching out to your lender may allow it to provide payment options or relief you weren’t aware of. This could be in the form of an extension, deferment, or restructuring of your loan.
Debt consolidation
If your credit is still in good shape, you may qualify for a debt consolidation loan. This allows you to pay off your defaulted debt and other debt accounts using one loan. It’s extremely important to make sure you can afford the payments on the new loan before considering this option.
Credit counseling
Credit counseling agencies offer budgeting, student loan counseling, and debt management services (sometimes for free). The Financial Counseling Association of America or the National Foundation for Credit Counseling could help you plan your budget and manage your debts to better handle your loan payments.
Hardship or forbearance programs
Federal student loans and even some private student loans offer forbearance or hardship programs for borrowers facing financial difficulties. Forbearance puts a temporary pause on your loan payments, though interest will still accrue. These are sometimes offered on personal loans, too, but you’d need to verify with your lender.
Loan modification (for mortgages)
If you’ve been struggling to make mortgage payments due to a loss of income or another financially challenging situation, your lender might offer the option for a loan modification.
You’d have to request the modification through your lender and file extensive paperwork detailing your current situation. The lender reviews your financials and decides whether to modify your loan for lower payments and a longer repayment term.
How to improve your credit
Improving your credit after a default may prove challenging, but it’s not impossible. Follow these tips to improve your credit score.
- Review your credit report: You can get a free weekly credit report through the end of 2023 from AnnualCreditReport.com, which pulls from all three credit bureaus. After 2023, you can get a free report from each bureau every 12 months from the same website. Make sure everything listed is correct. If you find an error, you can file a dispute.
- Make payments on time: Payment history is the largest component of your credit score, so making on-time payments consistently over time will help your score grow. Prioritize your loan payments and other necessities in a budget and set up autopay for loan payments when possible.
- Pay down other debt: Credit utilization is another large chunk of your credit score. Paying down revolving debt frees up your credit limits and boosts your score.
- Wait it out: A loan default stays on your credit report for seven years. Unfortunately, there’s no getting around that. But the impact it has on your credit report dulls over time until it falls off. Once it does, you should see your credit score increase.
FAQ
How does default affect my credit score?
Defaulting on a loan negatively impacts your credit score. It signals to credit bureaus and future lenders that you are less likely to repay the money you borrowed. If you started with excellent credit and defaulted on a loan, your credit score could drop substantially.
How can I prevent my loan from going into default?
Prevent your loan from going into default by proactively contacting your lender. You could also consider hardship programs, forbearance, or deferment, depending on the loan type. Credit counseling and debt consolidation could also keep you from defaulting on a loan.
Can I still qualify for future loans or credit after defaulting on a loan?
You can still qualify for future loans and credit after defaulting on a loan. However, the impact on your credit score makes it more difficult and more expensive to qualify for future loans.
How long does it take for a loan default to be removed from my credit report?
A loan default takes seven years to fall off your credit report unless it was done in error, which is rare.
