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If you’re behind on debt payments or in financial difficulty, a loan default can be a terrifying possibility looming on the horizon.
The consumer loan default rate hit record lows during 2020 and 2021, despite the broader economic downturn. This counterintuitive phenomenon was due in part to the government’s COVID-19 relief initiatives, such as stimulus payments and improved unemployment benefits.
But as those initiatives wind down, banks are seeing borrower defaults creep up from pandemic lows. For example, Wells Fargo has started to see “very, very small amounts of increases in delinquencies,” CEO Charles Scharf said at the Goldman Sachs US Financial Services Conference in December 2021..
Defaulting on a loan can have a serious negative impact on your financial life, from lowering your credit score to losing your home or car, lawsuits and even wage garnishment. But by taking steps now to come to terms with your lender, you may be able to get your debt under control and avoid the worst consequences of default.
This is what you should know.
What does it mean to stop paying a loan?
Defaulting on a loan means that you have not made payments according to your loan agreement and the lender believes that you do not intend to make any more payments. Unlike a delinquency, which can occur after a single late or missed payment, a default is much more serious and fundamentally changes the nature of your loan.
Most lenders will start reporting missed payments to credit bureaus after 30 days, says Amy Lins, vice president of business learning at Money Management International, a nonprofit credit counseling agency based in Sugar Land, Texas. . If you continue to miss payments, your lender will consider the loan to be in default. For private loans like personal loans or private student loans, it’s up to the creditor to determine how long it can take before the loan is considered delinquent or in default, Lins says.
Failure to comply can have serious consequences on your credit score and your finances. Because of this, if you are currently delinquent or unable to make payments on a loan, it is best to contact your lender to discuss alternative options rather than letting your loan default.
How loan default works
Although default and delinquency are sometimes used interchangeably, the two terms mean different things. As soon as you miss or are late on a payment, your loan is considered delinquent, says April Lewis-Parks, director of corporate communications for the national nonprofit credit counseling organization Consolidated Credit. Depending on the terms of your loan agreement, a delinquency may result in late fees or other penalties, but it typically won’t affect your credit score until you’re more than 30 days late on a payment.
If you are behind on loan payments due to financial hardship, contact your lender directly as soon as possible to try to reach an agreement before your loans go into default.
Once you’ve been delinquent for a certain period of time, your loan will go into default and your lender will start taking steps to get that money back. Ultimately, it’s up to the creditor how they handle their bad debts, Lins explains. They may try to contact you through their own internal collections team or work with a third party collection agency. As a last resort, they may sell it at a discount to a debt collection agency, which would then own the debt and may try to collect from you.
Depending on the specific type of loan, the lender may also take other actions after a loan has defaulted. Some examples include:
Auto loans: Auto loans are secured by your vehicle, which means that if you miss payments, your lender will repossess your car and try to sell it to recoup their losses. If the car’s resale value doesn’t cover the outstanding amount, lenders also have the option to take legal action and get a judgment against you for the difference, Lins says. For example, if you owe $17,000 on a delinquent car loan and the lender was only able to sell the car for $15,000, they may take legal action to get the remaining $2,000 from you.
Mortgages: Because your mortgage is backed by your home, which serves as collateral, defaulting on your loan will result in the lender seizing your property through a process known as foreclosure. The exact foreclosure process will vary depending on the laws in your state. Some states require a judicial foreclosure, which requires the lender to obtain a judgment from the courts, while other states allow non-judicial foreclosures, which do not require the lender to go to court and therefore can proceed much further. faster.
Student loans: When private student loans go into default, they are generally treated the same as personal loans and credit cards. But federal student loans go through a different process. After 30 days have passed since you last made a payment, a federal loan is considered delinquent. When you reach the 270-day mark, you are considered in default. Student loans are unique in that the federal government can garnish your wages without a court order if you default, while most other types of debt require a creditor to take you to court first.
What are the penalties or consequences of defaulting on a loan?
Depending on the type of loan you default on, you could face serious consequences ranging from a damaged credit score to asset seizure and possible legal action. These are some of the most common consequences of defaulting on a loan:
- Damaged Credit Score: Regardless of the type of loan you default on, you will almost certainly see a serious and lasting negative impact on your credit score. Your payment history makes up 35% of your credit score, and a default can stay on your credit report for up to seven years. This could make it more difficult to qualify for new credit in the future.
- Seizure of assets: If you default on a secured loan, a loan that is backed by collateral, then the lender can seize the asset you used as collateral and sell it to recoup the cost. Common secured loans include mortgages, which use your home as collateral, and auto loans, which use your vehicle as collateral. Home equity loans and HELOCs are also secured loans backed by your home. Some personal loans may also be secured, and the exact collateral required varies by lender. Losing your home or car can change your life, so it’s especially important to avoid letting secured loans default if you can.
- Legal action: If you default on a loan, your creditor could take you to court to recover the amount owed. The exact process depends on the laws of your state, but if your creditor can obtain a court order, he may be able to collect your personal property or garnish your wages.
- Wage bill: While most types of debt require a creditor to obtain a court order before they can garnish your wages, federal student loans are different. If you default on a federal student loan, the federal government can garnish up to 15% of your disposable income to pay off your debt without taking you to court. The government can also do a treasury offset, Lins says, where it takes money out of your tax refund or social security benefits to pay off your debt.
How to get out of default
1. Contact your lender
If you anticipate that you won’t be able to keep up with your loan payments, contact your lender as soon as you can. Explain your situation and see if you can negotiate a payment plan to get back on track. Most lenders would rather work with you to find a solution before you default, rather than go through the expense and hassle of collections.
Especially in the current environment, “lenders are really willing to work with people,” says Lewis-Parks. “Then [consumers] You shouldn’t be afraid to get close. It will never get worse.”
If you’re behind on your mortgage, talk to your lender about options to avoid foreclosure. You may be able to enter into a forbearance agreement, in which the lender allows you to reduce or pause payments for a certain period of time. Or, you could work out a loan modification, where the lender adjusts the terms of the loan to lower your monthly payment.
2. Rehabilitate or consolidate your federal student loans
There are two main ways to get out of default on a federal student loan: rehabilitation and consolidation.
Under rehabilitation, you will work out a new payment plan with your loan provider that is based on your discretionary income. After nine on-time monthly payments under a rehabilitation agreement, your loan will no longer be in default and the default record will be removed from your credit report.
Loan consolidation allows you to consolidate your delinquent federal loans into a new Direct Consolidation Loan and repay the new loan under an income-driven repayment plan.
A third, but less common, option is to pay off your delinquent loan in full. This may not be feasible for most borrowers, but it could be an option if you previously defaulted on your loan, but have since received a windfall and now have the funds to pay it off in full.
3. Seek help if you need it
If you feel overwhelmed by debt or don’t know where to start, consider seeking help from a nonprofit housing or credit counseling agency. A professional counselor can advise you of your options, help you strategically prioritize your debt, and help you negotiate with your creditors or put together a debt management plan.
“One of the things we really do is help [consumers] break that cycle of inaction, understand what their options are, help them make a plan and move on,” says Lins.
Some credit counseling organizations may charge a small fee for their services, but generally you will not be charged if you are in financial difficulty.
A housing counseling agency offers guidance related specifically to housing, including mortgage default and foreclosure, while a credit counseling agency can offer help with multiple types of debt, from credit cards to personal loans and home loans. student.