Loan defaults are when borrowers struggle to repay back borrowed money. This can be an extremely stressful situation for both the borrower and lender, and can lead to serious consequences, which range in severity.
According to S & P Global Market Intelligence, there were a record number of loan defaults in May 2020, totalling $10.54 billion. With this in mind, Dollar Hand explains what happens if you default on a loan and how to avoid this financial stress.
What Is A Loan Default?
A loan default is when you borrow money and then fail to meet repayments on time. When you apply for a loan you will sign a contract with the lender agreeing to pay back the money, plus interest on agreed upon dates.
If you fail to meet the terms of your loan agreement, then the lender will state that you have defaulted on the loan. This will usually only occur if you consecutively miss multiple payments over several months.
Perhaps you have lost your job and are unemployed or faced an unexpected financial expense that is urgent and prevents you from paying back your loan on time. If this happens and you default on your loan, you can face some serious consequences. However, you can be rest assured that you are not alone as this does regularly happen to many borrowers.
What Happens If You Default On A Loan?
Defaulting on a loan can lead to many negative consequences which can be stressful to deal with. Examples include:
Damaged Credit Score
Defaulting on a loan will damage your credit score as the lender or debt collection agency will be obligated to report this to the major credit bureaus. This can make it more difficult to borrow money or apply for credit in the future as a defaulted loan will stay on your credit report for 7 years.
This means that you may struggle to get approval going forward or you may be offered less favorable terms such as higher interest rates as you will be seen as a riskier borrower. A poor credit score can also sometimes interfere with other aspects of your life, such as your ability to rent a property or secure a job.
If you have borrowed an unsecured loan, it can also lead to extra charges and late fees, and the lender may insist that you repay the entire loan amount plus interest straight away. If you fail to achieve this, they will usually send your loan to a collection agency so you might face continuous collection calls requesting payment.
Wage garnishment, usually enforced through a court order, could also occur whereby money is taken directly out of your next paycheck to repay back the loan. If a lawsuit is involved, it is possible that the judgements against you could become public record too.
Loss Of Assets
If you have taken out a secured loan, your collateral could be seized so that the lender can recover their losses. This would mean that you could risk losing the asset tied to your loan, for instance your car or property. Defaulting on a loan is therefore very serious so you should try to avoid it as much as you can.
How Can You Avoid Defaulting On A Loan?
To avoid defaulting on a loan, it is essential to only borrow an amount that you can comfortably afford to repay back. So if for instance you wish to borrow $800, maybe request $600 or $700 instead. Do not overborrow!
You could also enroll into ACH Authorization whereby the repayments are automatically withdrawn from your account. This way you do not need to worry about forgetting to manually pay back the loan and potentially defaulting.
You should also get in touch with your lender immediately if there is a chance you will default on the loan. If you explain your financial situation, for instance if you have just lost your job, then they may be more understanding. Your lender may be able to offer you a more flexible alternative repayment plan and prevent you from facing extra charges and a negative impact to your credit score.
Most lenders will usually give you a grace period for making late periods. This tends to be a short amount of time after the payment is due whereby you will not incur any penalties for failing to repay back your loan but your loan may still continue to accrue interest. Check your loan contract to see if your loan comes with a grace period and try to repay back the borrowed money within this period as if you do not, then your loan will default.
If you have lots of outstanding repayments, then you could also consider consolidating your debt. By rolling all your debts into a single debt with one monthly payment, then you may be less overwhelmed with your finances which in turn can help you pay them all off on time so you do not default.
Whilst defaulting on a loan is not the end of the world, it can lead to serious consequences that can become very unpleasant to deal with. Following the tips mentioned above and trying to avoid getting into this situation will certainly be beneficial for both your financial and mental health.
Justine is a full-time writer with lots of expertise and a wealth of experience in the financial world. In particular, she specializes in household income and consumer finance across the United States. Follow her articles for useful advice and top tips, guides on how to save money and lots more.