Paying back a personal loan doesn’t always go according to plan. A financial setback like a loss of income or unexpected expense can suddenly leave you unable to make a payment. Before long, getting caught a little short can turn into a long-term problem.
Taking out a loan is a serious legal and financial obligation. That means there are consequences if you default on a personal loan. However, there are also options if you find yourself in that position.
The better you understand both the implications of a personal loan default and the alternatives available to you, the better you can minimize the damage.
What Does it Mean to Default on a Personal Loan?
There are two different terms often applied to late loan payments: delinquent and default. The difference is a matter of how late payments are, and how serious the consequences can be.
Any payment that is past its due date is considered delinquent.
Being delinquent might trigger a late fee or a penalty interest rate. It might even show up on your credit report. However, you can easily get back on track by catching up on what you owe and making future payments on time.
Being in default is a more serious matter.
A personal loan default means you’ve violated the terms of your loan agreement to the extent that the lender has reason to doubt that you’ll ever repay what you owe. This entitles them to take further action.
Leslie Tayne, founder and managing director of Tayne Law Group, explains what this typically entails:
“While borrowers should look at their loan agreement for the exact amount of time as well as the repercussions associated with default, a loan is generally considered to be in default after 90 days of missed payments,” Tayne says.
Depending on the lender’s policies, even payments that are only 30 days past due could be reported in default to credit bureaus. If your payment is late, chances are your lender will contact you before taking any further action. However, if you fail to respond, the consequences can get much more serious.
Consequences of Personal Loan Default
A personal loan default can trigger a series of negative consequences:
— A higher interest rate. Your loan agreement may include a default interest rate. This is higher than your regular interest rate, and applies if the loan is in default. This raises the cost of the loan, in addition to late fees.
— Reporting to credit bureaus. The lender can report to the credit bureau that your loan is in default.
— Debt collection. The lender may refer your account to a collection agency, which will probably take aggressive action to get you to pay up.
Damage to Your Credit Score
Tayne points out that having a default on your credit report can really hurt your chances of getting credit in the future.
“Defaulting on either a secured or unsecured loan can damage your credit and remain on your credit reports for up to seven years,” Tayne says. “Defaulting on a loan is a red flag for lenders because they want to reduce the risk of lending money and not getting it back.”
Defaulting could also do long-term damage to your credit score. This depends in part whether your credit score was already badly damaged.
By the time your loan enters default status, you will probably have missed more than one monthly payment. Megan Shepherd, an editor at Finder.com, explains how this compounds the problem:
“Multiple missed payments can count as separate occurrences,” Shepherd says. “So, the longer you’re late, the more damage to your credit. How much your credit score drops depends on the number of missed payments, where your score was to begin with and other factors in your credit history.” Shepherd notes that borrowers have reported seeing their scores drop anywhere from 80 to 150 points.
If you default on a personal loan, expect it to be harder to get credit for years to come. In addition, you’ll still have to deal with the legal consequences of the defaulted loan.
Repossession of Collateral
One of those legal consequences may involve any collateral placed on the loan. This depends on whether the loan was secured or unsecured.
With a secured loan, you agree to provide personal property as a guarantee of payment. This is known as collateral. The loan agreement will specify that the lender has the right to claim that property if you default on the loan.
Not all personal loans require collateral. However, providing collateral typically qualifies you for a lower interest rate on the loan, because the collateral gives the lender some protection.
So, with personal loans you have a choice: either pay a higher interest rate on an unsecured loan, or put some property at risk with a secured loan.
Debt Collection Lawsuits
Even if your loan is unsecured, lenders still have legal measures they can take if you default.
Because you signed a loan agreement, you are personally liable for repaying the loan, plus any interest and fee charges assessed according to that agreement. If you have personal property or earnings that can be used to pay the debt, either in full or in part, a lender may sue you to collect that way.
If you don’t have assets that can be used to repay the debt, in most states the lender can sue to garnish your wages to recoup the amount owed. This generally allows them to take up to 25% of your disposable earnings until you’ve repaid what you owe.
If you receive notice that you are being sued, don’t ignore it. If you fail to respond, a judge can simply decide in the creditor’s favor without you having an opportunity to state your side of the story.
Read the legal complaint carefully and compare it with your records. Make sure it is accurate in terms of the amounts owed and how long they are overdue.
You may also want to get legal advice. If you can’t afford to hire a lawyer, there may be free legal aid available in your area.
What to do if You Can’t Pay Your Personal Loan
Getting sued or having collateral seized are severe consequences for personal loan default. Fortunately, there are alternatives that can lead to a better solution. Here are some suggestions:
— As soon as you realize you can’t make a payment, check your loan agreement. This should let you know how long you have before you’re considered in default. It should also inform you about any other consequences of missing a payment, such as late fees and penalty interest rates.
— Don’t hide from your creditor. “If you’re struggling to make payments, it’s important to reach out to your lender as soon as you can to see if there are any reduced payment plans or hardship programs they might offer,” Tayne says.
— Consider whether refinancing the loan might help. This works best if doing so can lower your interest rate. Even if you can’t get a lower rate, refinancing might make your payments more affordable by extending the repayment period.
— Try credit counseling. If you’re having trouble figuring out what to do, credit counseling may help. This can involve anything from explaining your options to managing a repayment plan for you.
Not being able to make a payment means your original plan for the loan has gone wrong. If that happens, the important thing is to make a new plan that will lead you to the best possible solution under the circumstances.
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What Happens if You Default on a Personal Loan? originally appeared on usnews.com
