Defaulting on a Debt

When you fail to make your debt payments when they are due, the creditor will eventually consider you in default of your credit agreement. The length of time it takes for a creditor to consider you in default varies by creditor. Defaulting on your debt can have serious consequences, including lawsuits and wage garnishments.

Private Creditor Debt

If you default on a debt to a creditor, such as a credit card company or a bank through which you have a loan, that creditor can file suit against you to collect the outstanding balance on your account. Unless you can prove the debt does not belong to you, the creditor can usually win a judgment that will give it the right to garnish your wages. Creditors may also file a request to intercept or garnish your state income tax returns.

Federal Debt

If you default on debt to the federal government, such as back taxes or federal student loans, the federal agency to which you owe the debt can garnish your wages, state income tax returns and federal income tax returns. Some federal agencies such as the U.S. Department of Education do not have to file suit against before beginning a garnishment. Unlike private creditors, federal agencies can garnish Social Security income for payment on a defaulted federal debt.

Credit Damage

Lenders most commonly use the Fair Isaac Corporation (FICO) credit scoring system provided by the three major credit bureaus, Experian, Equifax and TransUnion. Your payment history and outstanding debt account for 35 and 30 percent of your score, respectively. Since these are the largest factors in calculating your FICO score, defaulted debt and judgments against you cause serious damage to your credit score. This can prevent you from obtaining loans and lines of credit in the future.

Considerations

Defaulting on debt has long-term consequences but sometimes it is unavoidable, for example due to job loss or illness. Before defaulting on your debt altogether, consider contacting your creditors and explaining your current situation to them. Many creditors are willing to negotiate payment arrangements that reflect your current financial situation. Once you begin paying down your outstanding debt, it improves your credit score and your financial future.