What does it mean to Default on a Loan?
When you borrow a sweater from a friend, you typically agree to return it once you are done wearing it. If you forget to return the sweater, it's not that big of a deal, because your friend will probably just remind you after some time has passed. Unfortunately, when it comes to borrowing money, if you fail to uphold your end of the bargain, the outcome isn't always so amicable.
Failing to make payments in a timely manner causes the loan to go into default. If your loan goes into default, it means you have not met the terms of the loan and you have not made your scheduled payments. Defaulting on a loan has serious consequences and often results in legal action requiring you to pay the outstanding balance, plus any applicable fees.
If you fail to make a payment on your loan, it does not automatically go into default. Instead, your loan becomes delinquent the first day after you miss a payment. If you continue to miss payments, after a certain amount of time, your loan will go into default. If you follow a monthly payment schedule, default occurs when you fail to make a payment for 270 days (approximately 9 months).
If you are supposed to make a payment less than once a month, default occurs when you fail to make a payment for 330 days (approximately 11 months). This timeframe is a good guideline, but the exact amount of time may vary based on what type of loan you have. It is best to check with your lender in order to know exactly when default occurs for your specific loan.
What to do in the Event of Defaulting
If your loan is in default, it is important to contact your lender immediately and fully explain your position. You should also ask the lender what options are available o get out of default and if they are willing to work with you to rectify the situation. It is imperative to always stay in touch with the loan issuer and keep them in the loop when it comes to the payment status of a loan in default.
The consequences of default are serious, so it is important to know what could happen if you fail to pay back your loan on time. Even before default occurs, the delinquent loan will be reported to the three major credit bureaus, damaging your credit rating. A low credit rating makes it much harder to get a loan for important items such as a house or car. It will also be difficult to get a credit card or possibly even land a new job down the road, because some employers check your credit history as part of their application process. Speaking of jobs, your employer, if requested by the federal government, can garnish your wages. Meaning, money from your paycheck can be withheld and sent to the government in order to pay off your loan in default.
Default also means the loan holder can take legal action against you in order to recoup the unpaid money. This type of legal action may also prevent you from purchasing or selling personal assets such as real estate. Plus, the amount of money you owe will increase if your loan goes into default, because late fees, additional interest, court costs, collection fees, and any other associated costs will need to be paid - in addition to the entire unpaid balance of your loan and any outstanding interest.
The Impact of Defaulting on a Loan
It will take years to recover from default and reestablish your credit, so it is important to know how to avoid this type of sticky situation. First and foremost, you should fully understand your loan agreement prior to signing on the dotted line. Know what you are getting into and carefully read your promissory note, because it is a legally binding contract. Plus, in order to avoid getting in over your head, do your best to only borrow the amount of money you need - and nothing more.
Keep any documents related to your loan organized, including your payment schedule, record of your monthly payments, and your promissory note. Lastly, if you can't make your monthly payment, switch plans to get a lower monthly payment, change your due date, or get a deferment or forbearance if possible.
Defaulting on your loan is serious business, so be sure to never ignore late payment notices from your loan provider. Do your best to stay on top of your payments and if you are having trouble, be sure to speak up and find an alternative solution. In other words, do everything in your power to prevent your loan from going into default, because there will be negative repercussions for years to come.