What Is Defaulting on a Loan?

When you open a new loan or credit card, you agree to make minimum payments on your due date. However, emergencies and financial hardships can make it difficult to keep that promise. If you stop making payments on your debt, the account will wind up in default. Here’s what it means to default on a loan, how it can affect you, and steps to take moving forward if you have a loan in default.

What does it mean to default on a loan?

Defaulting on a loan means you’ve stopped making payments on a debt you owe, “essentially violating the terms of your credit or loan agreement,” says Tara Alderete, the director of enterprise learning at Money Management International. 

This can lead to serious consequences, such as a damaged credit score and potential legal action from the lender. If you’ve used an asset as collateral — such as a car, house, or cash deposit — the lender may repossess it to satisfy the debt. 

When you get a bill, it should include a specific due date when payment is expected. 

Loan delinquency vs. loan default

The difference between loan delinquency and default is the status of the missed payment.

Definition of loan delinquency

Your debt generally becomes delinquent the first time you haven’t made a full payment by the due date or by the end of the grace period. The due date and grace period should be written into your repayment agreement and included on your monthly statement. 

When does delinquency become default?

An account moves from delinquent to default after the borrower consistently misses payments over a longer stretch of time. Default may have more serious consequences than delinquency, Alderete says. The timeline of default can vary by the type of loan you have:

• A mortgage is in default once a payment is 30 days past due, or you’ve breached your contract in other ways, like failing to pay your property tax bill.
• A federal student loan is considered in default after 270 days of no payments. 
• Credit cards typically are in default when a payment is 180 days past due.
• An auto loan is typically in default after a payment is 30 days late.
• A personal loan is in default after 90 days without payments. 

Consequences of defaulting on a loan

Missing multiple payments can lead to serious loan default consequences, including:

Impact on credit scores

Once you’re at least 30 days past your bill’s due date, your lender will likely report the late payment to the credit bureaus. Each credit bureau adds the information to your credit reports. Credit-scoring companies, such as FICO, use the information on your credit reports to calculate your credit score. The negative payment information on your credit reports could “significantly lower your credit score, making future borrowing harder,” says Bruce McClary, senior vice president at the National Foundation for Credit Counseling. 

Late fees

A bill that’s even one day late could result in a late fee, which is added to your account balance. The late fee varies based on the type of loan you have and the agreement you signed. Some lenders are limited on the maximum fee they can charge. Large credit card issuers, for example, may charge up to $8 for each missed payment. 

Collections

After the first missed payment, your lender will likely try to contact you via phone, mail, or email. If the loan reaches default, the lender may send your account to a collection agency. The agency will then start contacting you for payment and report the new negative account to the credit bureaus.

Legal actions and wage garnishment 

Your creditor — which may be your lender or a collections agency — could also sue you for past-due amounts. If it wins, the lender may take money from your bank account or garnish your wages. A wage garnishment forces your employer to send part of your paychecks to your creditor for payment. 

If the loan is secured, the lender may repossess the collateral, such as a car or house.

“These consequences could also include additional legal fees, making the amount of the original debt much more costly,” Alderete says.

Loss of eligibility for future loans and financial aid

Defaulting on a federal student loan might also make you ineligible for financial aid and future loans. 

Common reasons for loan default

Borrowers miss loan and credit card payments for a variety of reasons, including:

Financial hardship and unemployment

Reduced income, whether it’s through a job loss or a reduction in hours, can make it difficult to keep up with living expenses and debt payments. Other hardships, like an illness, injury, or divorce, can also strain your finances and result in loan default. If you don’t have one yet, consider building an emergency fund to help you get through a financial pinch.

Lack of understanding of loan terms

Your loan or credit card agreement should spell out important terms like your monthly payment amount, interest rate, due date, and grace period. Confusion over these terms may result in delinquency or default. 

If you’re confused about your loan terms, contact your lender and ask for clarification. Make sure you understand how to keep the account in good standing.

How to avoid defaulting on a loan

If you haven’t defaulted yet but you’re concerned about your ability to pay the bills, here’s how to avoid loan default:

Communicate with your lender

If you’re in an emergency situation or struggling to make payments on your loan, “contact the lender at the first sign of trouble,” McClary says. Lenders may be able to offer temporary hardship plans, such as lowering your interest rate or monthly payment. You can also ask about permanent solutions that make repayment more realistic. 

“In most cases, creditors want to help you, and they’ll likely be willing to work with you during a financial hardship or other situation,” Alderete says. 

Explore deferment or forbearance options

Deferment and forbearance both allow you to temporarily pause or reduce your monthly payments. One difference between the two is how the lender calculates interest while you’re enrolled in the plan. During forbearance, interest usually continues to accrue and is added to your principal balance. This increases the interest you pay over the life of the loan. During deferment, interest might not accrue in some cases; check with your lender to find out what you’re eligible for.

Review your finances 

Going over your financial situation can help you identify your problem areas and get you on the right track. Start by creating a budget: First, calculate your income, living expenses, and debt payments. Then, track your expenses from the past few months to see where you can remove nonessential spending, such as streaming services or takeout meals. 

“Increasing income through part-time work or freelancing can also provide extra funds for loan payments,” McClary says.

Steps to take if you've defaulted on a loan

If you’ve already defaulted on a loan, here are some options that can help remediate your finances: 

Loan consolidation options

Debt consolidation generally involves taking out a new loan to pay off all of your loan and credit card balances. Merging all of your balances under one payment can help make your debt more manageable. If your loan’s interest rate is lower than what you’re currently paying, it can also help you save money or better afford the payments. 

Seeking financial counseling

A credit counselor can help you by providing free or low-cost guidance for your situation. They’ll help you go through your budget, prioritize your payments, and potentially enroll you in a debt management plan. With this type of plan, the counselor can also negotiate with your creditors on your behalf to help make your payments more manageable.