If you fail to make timely payments on a personal loan, several repercussions may occur. First and foremost, your credit score will be negatively affected, making it more challenging to secure future loans.
Additionally, the lender may take legal action to recover the unpaid amount, which could result in wage garnishment, asset seizure, or a lawsuit. It is crucial to communicate with the lender if you anticipate difficulty in making payments to explore potential solutions and avoid defaulting on the loan.
Although it is important to strive to avoid defaulting on a personal loan, there are instances where it can occur. Understanding the consequences of defaulting on a personal loan, as well as the necessary steps to take and how to resolve the situation, should be a priority. By being prepared and proactive, you can navigate the challenges that come with loan default and work towards finding a solution.
What are the implications of defaulting on a personal loan?
Defaulting on a personal loan occurs when the borrower falls behind on their loan payments. While lenders may not immediately pursue action for the first missed payments due to the costs involved in debt collection, they are aware of the default. If the borrower fails to repay the missed payments and the default persists, the lender will likely invoke the default provision stated in the loan agreement.
When does a personal loan enter default?
A personal loan is considered in default when there are missed payments that exceed 30-90 days after the due date. It's important to note that a loan doesn't immediately go into default if a payment is missed by just a few days, but rather it becomes delinquent.
Late payments may incur associated fees, but they usually aren't reported to credit bureaus until they are 30 days past due.
How does loan default work?
Loan default typically applies to personal loans with unpaid payments that are at least 30 days overdue. Delinquent payments, which are payments that are less than 30 days late, may come with fees but generally do not harm your credit score. If a personal loan reaches the default stage after 30-90 days of missed payments, the lender takes action.
At this point, the lender decides on the next steps to recover the funds. They may contact you directly or engage a third-party to initiate debt collection efforts. For loans secured by collateral, such as a car loan, the lender may attempt to repossess the collateral. In the case of a mortgage loan default, the lender may proceed with seizing the property.
Consequences of defaulting on a personal loan
Defaulting on a personal loan can have severe and lasting consequences. In addition to significantly impacting your credit score, defaulting on a personal loan can lead to the following outcomes:
- Legal action: If lenders are unable to locate you or recover the owed funds, they may pursue legal action against you. They may also take you to court if the proceeds from selling seized assets don't cover the remaining loan amount.
- Asset seizure: Secured loans backed by collateral may result in the lender seizing the asset. However, if the asset's value is insufficient to cover the loan, they may still pursue you for the remaining debt.
- Credit score damage: Defaulting on a loan can have a significant negative impact on your credit score. Defaulted payments can cause credit scores to drop by up to 100 points and may remain on your credit history for up to seven years.
While the default rate for personal loans is relatively low, it is crucial to avoid defaulting for both financial and personal reasons.
How to avoid loan default?
The best approach to prevent loan default is to create a repayment plan when obtaining the loan. Set aside sufficient funds each month to cover the loan payment before using discretionary income for other purposes. This ensures timely and complete payments. It's essential to refrain from using the set-aside funds for other expenses during the month.
If your loan is already delinquent, prioritize repaying the outstanding amount promptly to prevent default.
How to recover from default?
If you are on the brink of default or have already defaulted, there are strategies to consider. Contact your lender immediately to address the issue. They may offer temporary payment suspensions or deferments under special circumstances. Familiarize yourself with debt collectors' practices, understanding their allowed and prohibited actions.
Consulting with a lawyer and seeking advice from a credit counselor can also be beneficial. They can assist in exploring options such as debt settlement to resolve the outstanding debt.