What happens if I default on a personal loan?
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Kathryn Pomroy is a personal finance writer with over seven years of experience. Her work has been featured by GOBankingRates, MSN, Kiplinger, and Fox Business.
Updated October 16, 2024, 2:47 AM EDT
Defaulting on your personal loan is different from being delinquent or late with a few payments. Loan default happens when you stop making payments altogether for a certain period of time, usually 30 to 90 days.
When you took out a personal loan, you clearly intended to pay it back, but something happened. You lost your job or had an unexpected emergency that left you strapped for cash. It can happen to anyone. The coronavirus pandemic may also be a part of your story. You might have lost wages for a while and couldn’t make your payments, so your personal loan went into default. Now what?
If you’re proactive, you may be able to minimize the damage to your credit. Here’s what you can expect if you default on your personal loan and what to do if that happens.
What happens if you default on a personal loan?
A personal loan comes with a structured repayment schedule. If you have come on hard times and can’t keep up with payments, then you're in danger of defaulting on your loan. The moment your personal loan goes into default depends a great deal on the lender and the terms of the loan. To report late payments to the credit bureaus, your payment must be at least 30 days late.
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Once in default, it can be a domino effect — your lender will reach out to recover its money. You may be contacted by a credit bureau, your collateral may be repossessed, and your credit will take a serious hit. It’s worth knowing that building credit is a lot easier than fixing your credit.
You will receive phone calls, emails, text messages or even letters from debt collectors as they attempt to recover the debt. Your lender will likely charge you a late fee, which is either a percentage of the payment due or a dollar amount after a grace period of between 10 to 15 days. This is usually stated in your original loan agreement.
With that in mind, if your personal loan is in default, you are protected under the law via the Fair Debt Collection Practices Act (FDCPA). It spells out what credit bureaus and debt collectors can and cannot do, such as make threatening calls, use obscene language, or harass you.
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What are the consequences of defaulting on a personal loan?
No one plans to default on their personal loan. But life happens and now your payments have lapsed. Unfortunately, defaulting on your personal loan has consequences that stay with you for years.
- You can damage your credit score
- Your cosigner could be on the hook
- Your collateral could be repossessed
- Your lender can garnish your wages
1. You can damage your credit score
As much as 100 points can be knocked off your credit score for simply making a few late payments. Defaulting on your personal loan will further damage your credit score, and can remain on your credit report for up to seven years.
When that happens, you may not qualify for new credit, as most lenders won’t work with you. And, if you do snag a new loan, your rates and terms will not be as favorable as when you had good credit. Plus, you will likely need collateral or a co-signer on any new credit.
2. Your cosigner could be on the hook
If you used a co-signer for your personal loan and the loan goes south, your co-signer is on the hook to make your payments. If for some reason your co-signer can‘t make the payments, their credit will also suffer.
3. Your collateral could be repossessed
Most personal loans don’t require collateral. But if your lender requires collateral to ensure payment on the loan, and you default on your payments, your lender can repossess your collateral; your car, investment accounts, or savings.
4. Your lender can garnish your wages
Even if your loan agreement doesn't call for collateral, your lender will find other ways to get its money. It can garnish your wages, place a lien on an asset you own, like your house, or worst-case scenario, your lender can take you to court.
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How can I avoid defaulting on a personal loan?
You can do a number of things before you apply for a personal loan to be sure you can make your payments on time every month.
- Don’t borrow more than you can afford. Many people live above their means and borrow more than they can easily repay. Make sure that’s not you or you may default on your loan. Look at your debt-to-income ratio (the percentage of your gross monthly income that goes to making your monthly payments) and make sure it’s about 36%, the number most lenders like to see when issuing credit.
- Talk to your lender. If you think you may become delinquent on your loan, be proactive and call or visit your lender to let them know before you miss a payment. Your lender may offer relief by deferring your payments temporarily, or by extending the term of your loan to make your monthly payment more affordable.
- Contact a credit counselor. Some credit counseling agencies charge a fee for their services. But it’s worth it to help get your good credit restored. Many non-profit credit counselors do not charge a fee for their services. They can set you up with a budget or may even negotiate new terms with your lender so that you can repay your debt.
- Call your lawyer. If worse comes to worst and you’ve been served with a lawsuit, you may want to contact your lawyer. And, don’t forget to show up in court or run the risk of the judge ruling in favor of your lender. You’ll be responsible for repaying the original loan amount still owed as well as court fees.
- Don’t apply for new credit. It may seem superfluous because most lenders won’t work with you, but if your personal loan is in default, do not apply for any new credit until you’ve repaid that debt. That means not applying for new credit cards or other loans.
- Ask for help from family and friends. It can be embarrassing to ask for a handout, but sometimes it’s necessary, especially if you think you may default on your loan. Before that happens, reach out to family or friends for help, and draw up a contract to ensure payments are paid back.