What Happens If You Default on a Loan?

Missing a loan payment can be stressful. Maybe an unexpected expense came up, your income changed, or you simply have more bills than your budget can handle right now. Whatever the reason, one missed payment does not necessarily mean you have defaulted on your loan. But if payments continue to go unpaid, the situation can become more serious.

Understanding what happens if you default on a loan, what loan default means, what could happen next, and what you can do about it can help you make more informed decisions about your money.

When Falling Behind Becomes a Default 

When you borrow money, you agree to repay it according to the terms of your loan. 

If you miss a payment, your account may first become delinquent, meaning the payment is past due. If the account remains unpaid long enough, the lender may consider the loan to be in default.

There is no single default timeline that applies to every loan. The timing depends on the type of loan and its terms. 

Federal student loans are one example. According to Federal Student Aid, a federal student loan generally goes into default after you have not made scheduled payments for at least 270 days.

For other types of loans, your agreement or loan servicer can tell you when missed payments could lead to default. The key point is simple: if you are having trouble making a payment, contacting your lender or loan servicer early can help you better understand your options. 

How Can Default Affect Your Credit?

Missed loan payments may be reported to the credit bureaus and can negatively affect your credit. Your credit reports contain information about how you have handled loans and other credit accounts. According to the Consumer Financial Protection Bureau (CFPB), negative information about your payment history can generally remain on your credit report for up to seven years.

That does not mean a missed payment affects your credit in exactly the same way for seven years. The CFPB notes that newer negative information generally has more effect on a credit score than older information. 

Why does that matter? Your credit history can play a part when you apply for another loan or credit card. Lenders use credit information, along with other factors, when deciding whether to approve an application and what terms to offer.

Could Your Account Go to Collections?

If a loan remains unpaid, the account may eventually be referred or transferred to a debt collector. 

If a debt collector contacts you, first make sure you understand what the debt is and why you are being contacted before you make a payment. 

Before discussing details about an account, a debt collector needs to verify your identity to make sure they are speaking with the correct person and protecting private information. Once identity is confirmed, the collector can provide information about the account. Federal rules require a debt collector to give you certain information about the debt. This is often called validation information. It includes information such as the name of the creditor, the amount being collected, and information about how to dispute the debt.

Not every defaulted loan follows the same path, but some unpaid accounts may eventually be referred to a debt collector.

If you believe the debt is not yours or the amount is wrong, you have the right to dispute it. The CFPB explains that sending a written dispute within the specified 30-day validation period generally requires the debt collector to pause collection of the disputed amount until it responds with verification. Even if you recognize the debt, it is worth understanding what you owe before deciding what to do next.

Could You Lose Your Car or Home?

Collections are not the only possible consequence of default. If your loan is secured by property, the lender may also have rights involving that collateral.

Auto loans and mortgages are common examples of secured loans.

If you fall behind on an auto loan, your vehicle may eventually be repossessed. Repossession rules differ from state to state. The CFPB notes that in many states, a lender may be able to repossess a vehicle after a missed payment without first getting a court order, while other states require additional notice.

Repossession does not necessarily eliminate the remaining debt. If the lender sells the vehicle for less than the amount you still owe, you may be responsible for the remaining amount, sometimes called a deficiency balance, along with certain allowable costs.

With a mortgage, continued missed payments can eventually put your home at risk of foreclosure. However, foreclosure is a process rather than something that happens immediately after one missed payment. If you are worried about making your mortgage payment, the CFPB recommends contacting your mortgage servicer as soon as possible to discuss available options.

Can You Be Sued Over an Unpaid Loan?

Legal action is another possible consequence of an unpaid loan, although whether it occurs depends on the debt and the circumstances. If you receive court papers relating to a debt, do not ignore them.

For many consumer debts, a creditor generally cannot simply decide to take money from your paycheck. According to the CFPB, most creditors can garnish wages only after going to court and obtaining a judgment that allows them to do so. Federal and state laws also place limits on garnishment.

Federal student loans, which follow different default rules from many private consumer loans, are also different when it comes to collection. Federal Student Aid explains that defaulted federal student loans can, after required notices and other steps, be subject to government collection methods such as wage garnishment or Treasury offset, which can include withholding a federal tax refund.

What Can You Do If You Are Falling Behind?

If you are struggling to keep up with loan payments, taking action early can help you better understand where you stand and what options may be available. Here is a simple step-by-step approach:

1. Review your account.

Start by checking your loan documents or account information. Confirm how much is past due, when payments were missed, and whether any additional fees or charges have been added.

2. Contact your lender or loan servicer.

If the account is still with your lender, reach out and explain your situation. Depending on the type of loan and your circumstances, repayment arrangements or other forms of assistance may be available.

3. Verify the debt if a collection agency contacts you.

If the account has been placed with a debt collector, make sure you understand the debt, the amount owed, and who the current creditor is. Ask questions if any information is unclear before deciding how to proceed.

4. Understand your payment options.

Once you have confirmed the account, discuss the options that may be available for resolving the balance. Keep copies of important letters, emails, payment confirmations, and other account records.

5. Know your rights.

Consumers have protections when dealing with debt collectors. The Fair Debt Collection Practices Act prohibits covered debt collectors from using harassment, deception, and certain unfair practices when collecting consumer debts.

A debt collection conversation should also give consumers an opportunity to understand their account and ask questions about what comes next. At Spire Recovery Solutions, the team focuses on respectful communication when reaching out to consumers about unpaid accounts. The goal is to offer clear account information, listen to consumer questions, and help individuals understand the options available for resolving their accounts.

Addressing financial concerns early may give you more time to understand your situation, ask the right questions, and explore the right solution for you. 

The Bottom Line

Defaulting on a loan can have serious consequences, but those consequences vary depending on the type of loan and your circumstances. They may include damage to your credit, collection activity, repossession of collateral, or, in some cases, legal action.

But knowing what is happening with your account and responding to it can put you in a better position to make decisions. When it comes to loan default, financial literacy does not mean knowing every rule by heart. It means recognizing when something has changed, knowing what questions to ask, and understanding where to go for information before the situation becomes more difficult.

Thank You to Our Sponsor, Spire Recovery Solutions

This Money Chat article is sponsored by Spire Recovery Solutions. Spire Recovery Solutions is a nationally licensed debt collection agency headquartered in Lockport, New York. The company was founded by U.S. military veterans Jacob Torriere and Joseph Torriere and works with creditors to help resolve outstanding account balances.

Consumers who are contacted by Spire can contact the company to ask questions about an account, verify information, or discuss available payment options. Spire also provides a secure online consumer portal for account management. To learn more about Spire Recovery Solutions and its consumer resources, visit their official website.