A loan default is a serious action that can have long-lasting consequences on debtor credit and other financial matters. A default involves breaking a contract with a lender, especially when it comes to payment terms. Much of the work lending organizations do is designed to decrease the rate of default on loans. Lenders tend to choose borrowers who have a low default risk, and they may help borrowers avoid defaulting by offering alternative payment plans if borrowers have trouble making monthly payments.
Definition
A default on a loan or contract occurs when the borrower fails to meet the specifications of the contract, the legal duty required by the loan. The loan contract states many terms the debtor must meet, especially regarding payments, such as when payments must be made, and how the loan must be managed. When the debtor breaks any aspect of these contracts, it is considered a loan default, and the lender takes steps to try to recover losses.
Common Examples
There are several types of common loan defaults. In mortgages, which have complex terms, there are several ways debtors can default. They can stop maintaining necessary insurance, such as homeowners insurance, as required by the mortgage, or they can stop making payments on time or leave late payments unpaid. In student loans or auto loans, a default tends to occur primarily when the debtor stops making payments altogether, and the lender assumes that the loan will not be paid off.
Loan Effects
Lenders that put an account in default status have several options. They can demand repayment and add a number of fees on the loan while bringing it back to a current status. This is a common action lenders take automatically. If the debtor is unwilling to work out a deal, a lender moves on to more serious steps involving direct legal action. For an auto or home loan, this typically means seizing the asset and selling it. Other lenders may be able to sue for repayment from debtor assets in general.
Credit Effects
While the legal repercussions of a default are bad enough, a debtor also damages his credit when choosing to default. Defaults show up on credit reports as a change in the status of an account. This not only raises red flags for any future creditors reviewing the report, it also drops credit scores significantly. This can make it difficult for consumers to qualify for a loan in the future and worsens the effects of processes such as foreclosures or bankruptcies.
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