Defaulting on a Loan: How to Avoid It and When to Keep Going

Not being able to pay your bills can feel like an insurmountable burden, but some circumstances in life can’t be managed. Losing a job, experiencing an expensive medical emergency, or facing another unexpected expense that is far out of your reach may mean you have no choice but to default on a loan. When these issues take place, it may seem like a good idea to avoid the issue altogether, letting accounts go to collections or having creditors come after you for payment. However, working to avoid a default or managing it once it happens are the best steps you can take. First, though, it is helpful to know what defaulting on a loan means.

What it Means to Default

Defaulting on a loan is a simple concept; it means you are not meeting your obligations to the loan provider as agreed when you signed your loan documents. In many cases, lenders do not consider a loan in default until several payments are missed, but a single missed payment may constitute default for other lenders. When you default, a lender will send you a reminder to pay within the first 30 days. If you do not make a payment and default continues after that point, you will likely face more serious consequences.

When a default takes place, your lender may report your loan to the credit bureaus. This can drastically reduce your credit score and make it more challenging for you to get access to new credit in the future. Unless a default is corrected, meaning payment is made, a lender can sell your debt to a collections agency who will then get in contact with you for payment. A default with your original lender may have less severe consequences on your credit report than a debt collection agency, but in either case, you will have a mark on your credit score for several years into the future.

Knowing When to Give In

Defaulting on a loan is not something most borrowers plan to do, but life circumstances make it impossible to avoid in some cases. If you are struggling to keep up with debt payments because of a low salary, a lack of income altogether, or because you are covering other required expenses each month, such as your rent or mortgage payments, defaulting may be the only option or try to find a smaller debt consolidation loan. Take a close look at your cash flow and see if there are items you can cut out to create more available funds each month. If the money simply isn’t there, defaulting on a loan may be your next step.

Understanding Your Cash Flow

On a month to month basis, most people are aware of what they bring in as far as income. What becomes challenging is the spending side of the line. When you aren’t paying attention to what’s going out each month, it can be hard to keep up with your monthly payments, potentially leading to default on a loan. If you aren’t sure where you stand from a cash flow perspective, here are a few tips:

  • Add up your required expenses, including rent or mortgage, utilities, and debt payments
  • Determine your “desired” expenses, including eating out, entertainment, or shopping
  • Use a budgeting app to help categorize spending
  • Review your spending each week to see where money is going
  • Work toward cutting out what isn’t needed
  • See if this amount can be used to avoid default

Types of Loans and Default

Giving in to a defaulted loan may have harsher implications depending on the type of loan it is. For instance, defaulting on a payday loan only impacts your credit when the debt is sold to a collections agency. However, default on this type of loan may ultimately cost you more than other types of debts because most payday loan providers require automatic payments to be established when a new loan is funded. Each missed payment means an insufficient funds fee from your bank, plus additional charges for a missed payment from your payday lender.
Other types of loans, including student loans, mortgage loans, and personal loans have the same impact on your credit, with or without falling into the hands of a collections agency. Your lender will try to collect from you directly, often for several months, before selling the debt to a collector. During that time, you may be able to avoid a collections account by following the tips mentioned below.

Tips for Avoiding Default

Outside of payday loan defaults, your best option for avoiding the negative issues that come with missing payments on loans is to touch base with your creditors as soon as you can. When you recognize there may be a problem with making a payment on time, contact each of your loan providers to let them know. Ask them what remedies they have for avoiding default. With student loans, for example, you may have an option to apply for a deferment or forbearance which temporarily stops payments. On a mortgage loan, your lender may provide other options for helping you avoid default and potential foreclosure.

Delaying a Payment
On personal loans and auto loans, your lender may be able to tack on your soon-to-be missed payment to the end of your loan. This extends your repayment term but helps you avoid default and its consequences. Taking the time to speak with your lender directly before a default takes place is the best way to avoid default when possible.

Debt Settlement as a Solution
If you cannot make payments on a debt any longer, you may also opt to negotiate with the debt collection agency once your lender has sold the debt off. You can see if they will accept less than the total amount due. Working with a debt settlement company can be helpful with this strategy, but be sure to understand the consequences of negotiating debts down.

The Bottom Line
Overall, default on a loan cannot always be avoided. Start by looking at your income and expenses to determine if the extra dollars you need are available. If they are not, work with your creditors to avoid default on the front end, or plan to negotiate with debt collectors if you can no longer make payments. Your credit score will take a hit when a default happens, but it may be your only option if your financial circumstances do not improve.

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