Consequences of Defaulting on a Personal Loan
If you’re overdue on your personal loan payments by a few weeks or months, you might face a loan default. Depending on the terms and conditions you agreed to, you might incur credit penalties, extra expenses, or loss of assets.
While the consequences sound daunting, knowing what they are can help you mitigate their impact. In this article, we’ll dive into what you need to know about defaulting on a personal loan.
Impact of loan default on credit score
Your credit score reflects your creditworthiness, which is based on your credit history and how reliable you are when it comes to repaying loans and debt. Defaulting on a personal loan can seriously drag down your credit score, leaving a mark on your credit report for up to seven years. Missing a single payment by 30 days could hurt your FICO Score, reducing it by up to 100 points.
When you’re 90 days late and considered defaulting on the loan, your credit score has likely already dipped due to missing the previous two monthly payments. Each negative event will affect your credit report, accumulating until you’ve repaid the outstanding balance. Lenders can report missed payments to credit bureaus after a short grace period.
After defaulting on a loan, it can take you years to reestablish a decent or good credit record and it can be much harder to get others to extend credit to you. Rebuilding good credit will require timely monthly payments.
If you find that you cannot repay the loan, not even through partial payments against the debt, you might need to file for bankruptcy.
It’s important to know that federal student loans operate differently from other personal loans, making them stickier and potentially more problematic to deal with. Defaulting on student loans (which fortunately allow you a grace period of 270 days) can result in your wages, tax returns, and even federal benefits being seized for debt repayment.
After seven years, any debt you’ve defaulted on will be removed from your credit report. It will be wiped even if you haven’t repaid it completely.
Legal actions taken by lenders against defaulters
In unsecured loans that don’t require collateral, it’s very common for lenders to take legal action if you default on a loan. That is, a lawsuit may be filed against you.
Debt collection lawsuits involve a creditor, either the lender or a debt collector they charge off your debt to, filing a claim with a state civil court. You (and co-signers, if any) will be listed as the defendant.
On top of the money you still owe plus interest, you might also be found liable for relevant attorney and court expenses if the case is ruled in the creditor’s favor.
If you default on a mortgage, you might face the consequence of a home foreclosure, which means the property gets seized. Similarly, your vehicle will be repossessed if you took out an auto loan with your car as collateral.
If you default on a student loan, the loan will be accelerated, which means that you become required to pay the entire loan off immediately. It can also cause you to become unable to get further federal aid.
Consequences of default on future loan applications
Since defaulting on a loan shows up on your credit history, it can negatively affect your likelihood of securing future personal loans. Lenders are typically significantly more cautious about loaning money to those who have a history of defaulting on their loans.
If you need a loan when you have poor credit, you’re less likely to get pre-approved or approved for personal loans. Some lenders might reject your application based on a bad track record of repaying debt. Even if you do qualify for a loan, you can expect to pay higher interest rates based on your history of defaulting.
Effect of default on interest rates and loan terms
If you default on a personal loan, you might notice a sharp rise in interest rates.
Future loans can also be negatively impacted due to a history of loan default. If you’re looking to take out a personal loan in the next seven years, you can expect higher interest rates due to creditors seeing that you have a history of late payments.
Personal loan interest rates range from 3 to 36 percent. The worse your credit score, the higher you can expect your interest rates to be.
Loss of collateral in case of secured personal loans
For secured personal loans, defaulting means the lender can seize the assets you put up as collateral. They might sell it to recoup the value they’ve lost for your loan defaulting. The collateral might’ve been anything of value you own, such as:
- Your property
- The title of your vehicle
- Your bank and savings accounts
Even if your assets have been repossessed following a loss of collateral, you might still owe more money to the lender. Assets will be taken until the debt has been adequately covered.
If your lender finds out that you no longer have possession of the collateral you offered (e.g. you sold it), you may end up having to pay more or arrange for assets to replace the collateral.
Negative impact of default on co-signer's credit score
If you had a co-signer on the loan agreement to help you obtain the personal loan, your loan default can affect them as well. The co-signer on a loan will become liable for the outstanding loan balance if the borrower defaults. The co-signer’s credit score will reflect any loan they’ve co-signed as though the loan is theirs.
For many personal loans, the lender will automatically request payments from the co-signer if the borrower misses a monthly payment. There is a lot of responsibility that falls on the shoulders of a loan co-signer.
Collection efforts by debt collectors after default
A while after you stop making on-time payments, your lender might stop contacting you about your loan. However, this doesn’t mean your loan has been forgiven. Instead, it likely means your case has been sent to collection. This unpaid loan balance might be given to the lender’s collections department or sold to a third-party debt collection agency.
Debt collectors are professionals who work to ensure that either they or the lenders recover the debt amount. They may email you, contact you on social media, send letters, call you, or reach out to you in other ways.
Debt collectors might take you to court in an effort to recover the unpaid loan balance. This may result in consequences such as your money being taken from your bank account or paychecks.
While they don’t have any special legal standings or powers, debt collectors can be frustrating to deal with when they attempt to get you to repay your debt. Legally, debt collectors are not allowed to use predatory or abusive methods to force you to repay the loan. If you feel like your debt collector is using unethical harassment practices or threatening you, you might be able to protect yourself by contacting an attorney.
Effect of default on employment opportunities
While not every state allows employers to check the credit history of job candidates, some do. Employers could decide to reject your job application if your credit score shows you have bad credit.
Bad credit reflects a sense of unreliability surrounding loans and debt. Someone with poor credit has either paid late, not paid the agreed repayment amount, or failed to repay debt at all.
The good news is that if you’re looking for employment in one of the following states, employers are restricted from running credit checks on you.
If you’re interviewing for a new job in a state that does allow employers to check the credit history of job applicants and you know you have bad credit, it might be prudent to prepare for questions about your credit history.
Possibility of being sued for outstanding debt after default
If you’ve defaulted on a loan, a lender or the debt collection agency that they’ve sold your debt to can sue you for your outstanding balance.
Getting sued means you might have to show up in court to defend yourself. An attorney can help you with your defense and build you a better case if necessary. Note that if you don’t show up, a judge may automatically rule in favor of the debt collector or lender.
Some common rulings of a loan default case are:
- Wage garnishment: The lender or debt collector gets the right to take a part of your wages
- Frozen bank account: The judge might order some or all of the money in your bank account to be frozen
- A lien against or foreclosure of your property: You lose the right to your property
In many cases, creditors don’t expect borrowers to show up to the debt collection hearing in court. However, it’s generally advisable to respond to the complaint and show up in court so you can try to reduce the debt you owe or even avoid it altogether. Sometimes, debt collection cases get dismissed.
A debt collection lawyer may be able to help you with the following things:
- Understand who the creditor is
- Verify if the debt they’re suing you for is accurate
- See if the debt has gone past the statute of limitations
- Create a timely and reasonable response to the lawsuit within a few weeks
Long-term financial consequences of default on personal finances
In the long run, defaulting on a loan makes it harder to get affordable personal loans in the future. Creditors who check your credit history might be less willing to give you an unsecured loan, or the interest rates may be higher.
Since loans will likely become harder to get with a loan default on your credit report, it can be more challenging for you to get financial assistance in the form of loans from lenders and financial institutions. Because of the burden defaulting on a loan can give you, it’s a good idea to pay off loans before they go into default. This can also help you avoid extra late fees and penalties.
Defaulting on a loan also has the consequence of making it harder to buy a house or car. Mortgages and auto loans are secured loans that look at your credit score and require collateral.
What to do if you default on a personal loan?
If you face a loan default, it’s understandable to be frustrated and stressed. However, it isn’t the end of the world and there are methods that can help people better handle the fallout of a loan default.
While everyone’s situation is unique, here are some generic strategies that can reduce a borrower’s chances of defaulting on a personal loan.
- Only take out a loan that is manageable and affordable
- Set up automatic payments so you make payments like clockwork
- Contact your lender if you’re struggling. They may be able to offer you temporary relief like a deferment or a modification of your loan terms
- Consider a debt consolidation loan to combine your defaulting loan with other accounts
- Seek the help of a credit counselor who may be able to help you better manage the debt
- Borrow against your existing home/retirement plan–but be careful of consequences
Loan default FAQs
When is your loan considered defaulted?
If your loan payments are 90 days late, you’re likely considered defaulted on your loan. The exact time until default depends on your loan type.
Can you get rid of a loan default on your credit history?
A loan default can stay on your credit report for up to seven years. You can rebuild good credit more quickly if you consistently pay off the debt in a timely manner.
**What should you do if you face a loan default? **
If you face a loan default, consider asking your lender for repayment relief. Review your options carefully and make the choice that makes the most sense for your personal situation.
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