What Is a Loan Default? What Happens When You Default

Lauren WardUpdated December 15, 2023

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Defaulting on a loan happens when you’re very late in paying your debt and the creditor is ready to take additional action to recover what it views as a loss. The actual process and consequences of loan default can vary based on many different factors, including the loan type.Read on to understand what happens at each step of loan default, plus get tips to avoid going into loan default altogether.

What Is a Loan Default?

Loan default is a final stage in a process that begins with you missing a loan payment. Let’s look at the process in order.

Grace period. This is a set time period after your payment on the loan is due but before the lender starts charging you interest or penalties. It can vary from several days to several weeks, depending on the type of loan and lender. In some cases, there may be no grace period.
Delinquency period. This is the period of time that follows immediately after your late payment grace period is over. Typically, when a payment is 30 days late, the creditor reports it to a credit bureau as delinquent. That means it may appear on your credit report as a late payment and affect your credit score. You may also be charged late fees.
Loan default. Generally, your loan goes into default after you’ve missed payments for a specific length of time determined by the lender. During the delinquency period, you may be able to negotiate with your lender to modify your payment schedule, at least temporarily. When you’ve reached the point of being in default, the lender has lost confidence that you’re going to actually repay the loan.

What Happens When You Default on a Loan?

During delinquency, you may have been on the receiving end of some collections activity. During default, expect that to intensify. In some cases, the lender or collection agency may try to work out a repayment plan with you. However, if your loan was secured by some type of collateral, the lender will probably start the repossession process. If the loan was unsecured, you could be sued and eventually have wages garnished to pay off your debt.The impact of defaulting on a loan largely depends on whether it’s a secured vs. an unsecured loan. If your loan was secured, you may lose whatever you put up as collateral. In either case, your personal credit score is likely to drop and you’ll be held responsible for the balance in some way, whether through a negotiated settlement, repossessed assets, or litigation to garnish your wages.If you default on a business loan, your company’s business credit will probably suffer and any assets you used as collateral may be repossessed by the lender. The lender may also opt to take you to court, which could result in a judgment lien, meaning that your lender may be given the right to take some of your property if you don’t pay off the loan.Even if you didn’t give a personal guarantee at the time you took out the loan, your personal assets could still be taken to settle your debts. Here’s a more detailed breakdown of what defaulting on specific types of loans may result in, depending on the type of account.

Credit Cards

After you start missing payments on your credit card, you’ll probably experience two financial drawbacks: The first is having a late fee assessed, and the second is being charged a penalty interest rate, which is higher than your normal rate. You may also have your credit limit decreased. Additionally, late payments after 30 days are put on your credit report. Every time another 30 days passes without your late payment being paid, a separate negative entry is added to your report.After a certain point, the credit card company will consider your account in default rather than just delinquent. The time frame may vary, depending on your credit card agreement, but it’s usually around the six-month mark. At that point, expect the collections process to start, which could eventually lead to a lawsuit if not addressed.

Auto Loans

Just like late credit card payments, any late car payments will be listed on your credit report after 30 days. Auto loans are secured by your car, so once you’re in default, you run the risk of having your vehicle repossessed by the lender. This gives it the ability to resell the car to take care of your outstanding balance. However, this process takes both time and money from the lender, so it’s usually a last resort. You may be able to negotiate some flexibility in your payment terms so you can keep the car and get your auto loan back in good standing. Recommended: Can You Refinance Your Auto Loan After Repossession?

Mortgage

A mortgage is another type of secured loan. Mortgages usually move from delinquent to default after you've missed four payments in a row. What’s the result of defaulting on a mortgage? Since your house is collateral for the loan, in a worst case scenario, the lender can take your house through the foreclosure process. The process will differ depending on the state in which you live, but regardless of location, you should get advanced notice that the foreclosure proceedings are about to begin. You may even be offered one more chance to catch up on your balance before the lender starts the foreclosure process. Having a foreclosure on your credit report causes lasting damage, as it stays there for seven years. Also expect a major drop in your credit score and difficulty qualifying for new credit.

Business Loan

The impact of defaulting on a business loan varies depending on whether it’s unsecured or secured. Some business loans also come with an accelerated balance once you enter into default. That means the entire loan balance becomes due, including any additional lender fees, like those associated with collections or the legal process. When a company defaults on an unsecured business loan, it could end up with a lien against it. If the loan was secured, the lender could seize whatever assets were used as collateral. This may be in the form of equipment, inventory, real estate, or even revenue. In either case, your business’s credit score will be damaged.Another factor impacting business loan defaults is the personal guarantee. The guarantee is typically required to get a business loan, even if you don’t have to put up specific collateral. If your business loan required a personal guarantee, your personal assets could be seized and your credit would be negatively affected, as well.

Student Loans

Technically, your student loan payment becomes delinquent if it’s one day late. But your loan provider doesn’t report it to the credit bureaus until it has been delinquent for 90 days. When you go into default depends on the type of student loan you have. For a loan taken out under the William D. Ford Federal Direct Loan Program or the Federal Family Education Loan Program, you’re considered to be in default when you haven’t made your payment for 270 days. For a loan made under the Federal Perkins Loan Program, your loan provider decides when the loan is in default. Regardless of what type of student loan you have, when you go into default, your entire loan, with interest, comes due and you’re no longer eligible for benefits, including deferment and student loan forgiveness. You may be sued, your wages may be garnished, and your tax refunds may be withheld to pay for what you owe, among other possibilities.

How to Avoid Defaulting on a Loan

Defaulting on a loan generally results in severe consequences and should be avoided at all costs. Here are some potential solutions to consider.

Contact Your Lender for Assistance

Your very first step when you discover you can’t make your loan payment should be to reach out to your lender and discuss your options. It’s in your lender’s best interest to work with you, since it can be costly for it to initiate the collections process and potentially the repossession process.

Refinance the Loan

You may be able to refinance your loan with terms that are better for you. Even if you don’t qualify for a lower rate, you might be able to reduce your payments by extending your loan term. That will make the loan more expensive over time, but you might avoid going into default.

Explore Alternative Business Funding

If you’re about to default on a business loan, including SBA loans and other types of financing, you might choose to explore quick financing solutions to bridge the gap. Short-term business loans and emergency loans for small businesses may be available to help give you the capital injection you need.

What to Do If Loan Default Is Your Only Option

In some cases, defaulting on your loan may be unavoidable. If that’s your situation, there are some tips that may be beneficial for you to follow if you want to advocate for yourself to the fullest extent possible.It might be a good idea to review the Fair Debt Collection Practices Act. This law outlines what measures a collection agency can take and where it must draw the line, as well as what your rights are. Another option to consider may be to enroll in credit counseling with a non-profit agency. It may help you review your financials and create a payoff strategy that’s within your means. Finally, get in touch with a lawyer as soon as you’re served any type of legal paperwork, whether it’s the start of a repossession or foreclosure process, or an upcoming lawsuit. Recommended: Can You Go to Jail for Not Repaying a Loan?

The Takeaway

A loan default is serious business, so ideally, you would try to avoid it by keeping up with all of your payments. If that’s not possible, you can call your lender as soon as possible to discuss your options before your bills become too far overdue. No matter what happens, keep educating yourself about your rights and responsibilities so you can navigate each stage with confidence. If you’re looking for a personal loan to pay off some debt and possibly avoid default, consider Lantern by SoFi. With just a single application, you can compare multiple options from top lenders in our network.

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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