What Does 'In Loan Default' Mean?

Loans are governed under contract law. A borrower receives something of value from a lender -- like cash or an asset like a car -- and signs a contract agreeing to repay the lender under certain terms and conditions. This contract becomes a binding legal agreement between the parties. If one party fails to live up to the terms of that agreement, he is said to be "in default."

Default Provisions

Most loan agreements contain a section that outlines the consequences if one party fails to honor the terms of the contract. Although each loan can have whatever provisions both parties find agreeable, in general, the default provisions outline the conditions that constitute a breach of the contract, which puts the loan itself "in default," and the mechanisms both parties have to try to resolve a default.

Lender Default

Although rare, it's possible that a lender could default. For example, a bank could try to finance the sale of a house to a borrower only to learn that the title to the house is contested. In a lender default, the terms of which are usually spelled out in the loan agreement, typically both parties are held harmless and the loan contract is simply voided.

Borrower Default

The most common cause of borrower default is failure to make regularly scheduled payments on the debt, although defaults for other reasons -- like not obtaining insurance on a house or car, or filing a fraudulent application -- do occur. When a borrower is at risk of default, the lender notifies the borrower and attempts to resolve the problem. When the lender cannot get mutually agreeable traction, it declares the loan to be "in default" and the default provisions of the contract take effect.

Consequences of Default

In default, most loans require the entire remaining loan balance to be repaid in full, immediately. If the borrower cannot make the lender whole, then the lender may pursue the full range of collection activity, including repossession, court judgments, garnishments and collection agencies, to recover its interest in the debt.

Some banks or credit unions may offer a reconciliation process to get a person out of default, but this is not common; once the contract is breached, it's breached. Some lenders, like the Department of Education, allow a defaulted loan to be rehabilitated, but the costs and impact to the borrower's credit report can be significant.