What happens if you default on a loan?

Working with your lender and taking action before you default are necessary to avoid default. If you can, explain your situation and seek out alternatives. Defaulting on a loan can cause long-lasting damage to your credit score, and in some cases, it can even result in being sued by your lender or having your property or assets seized.

What is default?

When you miss a few payments, your lender may just charge you late fees rather than send your loan to collections. When you regularly miss payments for an extended period of time, you will default on your loan. Depending on the type of loan, this can be anywhere from one day to 270 days since the last payment.

“Defaulting on a loan is much more serious than being delinquent, says Bobbi Rebell, certified financial planner and personal finance expert at BadCredit.org. “Delinquency usually means missing a few payments or falling behind on due dates.”

Rebell says if a borrower defaults, there can be serious consequences because it means the borrower has effectively broken the terms of the loan agreement. As a result, she says the lender no longer has to stick to the agreed-upon installment plan and can demand payment of the entire loan. When this happens, your loan will be sent to a debt collection agency to recover the unpaid balance.

Is defaulting on a loan a crime?

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. It can also be considered a civil offense, meaning that the lender could sue you for the unpaid amount.

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 or payment relief options.

Credit damage

If your monthly payments are more than 30 days late, the lender may report the delinquent balance to one or more 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, negatively impacting your credit health and history as well. A negative repayment history will remain on your report for seven years and can reduce your approval eligibility for future loans. And if you are approved, you’re more likely to be offered a much higher interest rate and need to work with bad credit lenders.

Late payment fees

Most lenders charge late payment fees for late or missed payments, which may fall somewhere between $20 and $40. However, 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 a payment within it, if possible.

If you do miss a payment, you may be able to negotiate with your lender to avoid a fee. 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.

Collateral seized

If you default on an unsecured loan, you will only risk fees and a potential court hearing — your assets can’t be seized without court approval.

However, if you default on a secured loan, your lender can seize the collateral used to secure the loan. A collateral requirement is uncommon with personal loans, but auto loans are a common type of secured installment loan where you may risk your property.

For example, if you default on an auto loan your lender may be able to repossess your car. That said, how soon a lender can seize your collateral depends on what type of installment loan you have and your state laws.

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. 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.

Debt collection can be stressful because the agency can contact you weekly, if not daily, about the overdue debt. All debt collection 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.

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 a 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 it for deceptive practices.

Potential court hearing

Your lender may sue you for unpaid debts in 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. 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.

How to avoid defaulting on your loans

To minimize your chances of defaulting on a loan, know your rights and take steps to work with your lender.

• Contact your lender: If you are facing an unexpected financial emergency or have had significant changes in your income, contact your lender’s customer service department and notify them.
• Request deferment or forbearance: Ask your lender if it offers deferment or forbearance, which temporarily allows you to pause payments without defaulting. While this can be convenient for short-term situations, lenders typically only offer a month or two at a time — and interest will continue to accrue on your loan.
• Sign up for credit counseling: If you need help creating a repayment plan that allows you to make on-time payments, consider working with a credit counselor. A credit counseling agency may also help you negotiate or negotiate with your lender on your behalf.
• Consider debt consolidation or refinancing: A debt consolidation loan involves taking out a new loan to pay off your existing one. If you can secure a lower rate, you could lower your monthly payment and pay off your loan sooner.
• Work with a lawyer: You can also hire a lawyer to negotiate your debts or help you understand your rights as a consumer. However, note that if a lawyer does help you settle a debt — pay less than what you owe — it can harm your credit.

Next steps

When you default on an installment loan, it can cause significant harm to your finances and credit profile. And depending on whether the loan is secured or unsecured, a lender can seize your collateral.

There are multiple steps you can take to reverse the damage of defaulting, such as becoming current on the loan through loan rehabilitation or rebuilding your credit. If you need help understanding your rights as a consumer or figuring out what steps to take, consider contacting a debt attorney or credit counselor.