If you’re facing financial hardship and fall behind on your bills, loan default is a possible consequence. Unfortunately, default can result in late fees, a drop in your credit score, and legal action.
If you’ve defaulted on a loan or are afraid you might, don’t panic. First, there are steps you can take to prevent a personal loan default, even if you’re having trouble making your payments. There are also options available once you’ve already defaulted.
What is personal loan default?
Personal loan default means you’ve failed to make your contractually agreed-upon payments. Though you could technically be in default after a single missed payment, many lenders don’t typically consider you to be in default until you’ve missed payments for 90 days.
Default can have both short-term and long-term financial consequences. Your credit score will decline, you may have a hard time accessing credit in the future, and, in extreme situations, you may even be on the receiving end of legal action.
Personal loan default consequences
There are several possible consequences of personal loan default.
- Late fees: Your lender may charge you a late fee as soon as the day after your missed payment. In fact, you’re likely to be charged a late fee before your loan is even considered in default.
- Missed payments reported: Your lender will report your missed payments to the three credit bureaus. These missed payments will negatively impact your payment history, and your credit score is likely to drop. The amount your credit score will drop after default depends on a variety of factors, but based on FICO data, the decrease could be upward of 100 points, especially if you had good credit to begin with.
- Debt could be sent to collections: Your lender might sell your debt to a collections agency, which would then pursue payment from you.
- Legal action: A lender could also sue you for the amount you still owe, possibly resulting in wage garnishment. A portion of your paycheck is then withheld to pay off your debt.
- Long-term credit impact: Missed payments remain on your credit report for 7 years, meaning your score may continue to suffer. During that time, you could be denied loans and credit cards or be charged higher interest rates due to the perceived increased risk of lending to you.
How to prevent personal loan default
Default isn’t your only option. Here are a few steps to take to avoid that outcome:
- Create a budget: If you’re struggling to pay your bills each month, your first step should be creating a budget. You’ll be able to see if you’re overspending or whether your income isn’t high enough to meet your financial obligations.
- Contact your lender: Your lender may be willing to work with you to modify your payments or even pause them temporarily. It’s best to contact them proactively, before you default.
- Tap into your emergency fund: Consider using your emergency fund to make your loan payments until you can get back on your feet. This is a short-term solution, however, as you don’t want to drain your savings.
- Set up automatic payments: Set up automatic payments to help prevent missed payments. Just note that this method isn't a failsafe. Your bank could still send the payment late, in some cases, so schedule autopays early so you have time to make sure they go through.
- Refinance your personal loan: This may only be an option if your credit hasn't yet taken a hit, as you'll want to have decent credit to qualify for a personal loan refinance. Even if you can't get a lower rate (and thereby a lower payment) through refinancing, you may be able to extend your the repayment term, which could lower your payment enough to make it affordable.
Tip
If your monthly payments are too high for your budget, consider a debt consolidation loan. Your debt is consolidated into one monthly payment, and you may get a lower APR, which can help ease the burden.
