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Loan Default

What happens when you default on a loan?

29 July 2022Lloyd Smith 5 min read
Loan Default: What Happens When You Default on Loan?

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Nobody takes out a loan without the intention to repay it. But life happens. Whether you had to default on a loan deliberately or due to uncontrollable circumstances, loan default can significantly blow your financial health and affect your credit score. It may even lead to losing collateral in case of secured loan defaults.

In this article, we take a look at what loan default is, what are its primary consequences, and how you can avoid it.

Loan default occurs when you fail to repay your loan's subsequent loan instalments by the due dates mentioned in the loan agreement.

However, loan default does not happen automatically after you miss repaying just one instalment.

When a loan repayment or multiple repayments get missed, payment delinquency is marked on your loan. The loan will remain delinquent until it is paid off or a separate arrangement is reached with the lender.

If a loan remains delinquent for a certain period, it can default. You can avoid loan default by reaching out to your lender during the delinquency period to reach a compromise. The delinquency period varies based on the default type and lender's policy.

Loan default can occur on both secured and unsecured loans.

Secured loans like auto loans or home loans may lead to the borrower losing the security/asset they have provided for the loan.

On the contrary, unsecured loans like student loans, payday loans, and credit card balances may lead to your credit score getting affected, high interest rate applied to the borrowed amount which can lead to increasing debt, and also make it difficult for you to get approved for future loan applications.

It's important to compare unsecured loans vs secured loans before you decide on the type of loan you want to get and understand the repercussions of defaulting on the loan.

The loan default consequences in Australia can be many, including:

Decreased credit score

One of the major consequences of a loan with default is decreased credit score. Defaulted loan can be added to your credit report and it can stay for up to five years. This can in turn affect your chances of getting approved for new lines of credit.

According to AOIC, your lender must send a default notice in writing to your last known address twice before listing your loan default on your credit report. It will be listed in your credit report if you have defaulted for at least 60 days and the defaulted balance is more than or equal to $150.

With a bad credit score, your options to get a new line of credit getlimited. You can either apply for personal loans for bad credit or get a credit card for bad credit – both of which can charge you high interest rates.

Difficulty in getting approved for subsequent loans

Loan default may make it difficult for you to get subsequent loans in the future. As mentioned above, once a default is listed on your credit report, it can appear on it for five years even if you repay the loan.

Although a single loan default on your credit report doesn't mean all of your subsequent loan applications will be rejected. But it can make it rather difficult for you to persuade lenders into approving your loan with a low interest rate and good repayment conditions.

Increased financial burden

Payment default may increase your debt burden. Some loan providers charge late fees after initial delinquency and an additional fee after default. All of these fees are added to your outstanding balance, and your interest rate is calculated based on the overall balance. A default interest rate can get you neck-deep in debt as the balance accrues.

Accelerated payment

In some cases, when a loan gets defaulted, lenders may require the immediate payment of the entire debt instead of the installment payment arrangements in the initial loan agreement.

Note that the lender only has the right to request accelerated payment if there is an acceleration clause in the loan agreement

Lawsuit

Lenders can also resort to a lawsuit to recover their debts. Especially in unsecured loans, lenders can transfer your debt to third-party debt collectors who can take an action against you for the repayment of the debt.

If the lenders get a judgment against you, the court may give a garnishee order against money in your bank account, wages, or other properties.

Despite the harsh consequences of loan defaults, you can still find your way out of it. The law permits you to request hardship assistance from your lender after receiving the default notice.

The hardship application outlines why you are finding it difficult to pay, how long the difficulty will continue, and your repayment plan.

Reasonable grounds for hardship assistance include illness, unemployment, or broken family. You may request payment postponement or reduction, interest rate reduction, or a default fee waiver.

Note that lenders are precluded from listing your payment default on your credit report when they are yet to communicate their decision on the hardship application. They can only do so after 14 days of communication and their refusal.

Lenders are also barred from listing the default in your credit report if you abide by the terms of the hardship assistance arrangement.

Programs like loan rehabilitation can also help you get out of a student loan if it is a government loan. A rehabilitation agreement with your lender can require you to pay a certain percentage of your monthly income for a fixed period. Once you abide by the rehabilitation agreement, the loan will be out of default.

In effect of the successful loan rehabilitation, your credit report will no longer reflect the payment default, but the missed payment that led to the loan default can remain on your account for seven years. Your credit score can also improve during rehabilitation due to consistent repayment.

You should note that you can only apply for loan rehabilitation once. And if that happens, you need to avoid future defaults.

Choose your lender carefully

Before you apply for a loan, research different lenders in the market and their loan terms. Evaluate their interest rate, additional fees, loan repayment tenure, and eligibility criteria. Ensure you choose what suits your needs and financial capability.

Have a repayment plan

Before you take out a loan, consider your ability to repay it and create an in-depth repayment plan. Ensure you have a stable source of income or cash flow from which you can service the loan. It's also a good idea to keep an emergency fund that you can easily access in case of unforeseen circumstances where you aren’t able to pay your loan repayments on time.

Thoroughly check the loan agreement

Always read and ensure you understand your loan terms and conditions. Do not miss any detail. Seek clarification from your loan officer at any time.

Doing due diligence helps you understand your loan repayment options and loan default consequences as well.

Renegotiate your loan arrangement

If you have already had payment delinquency and you realise you cannot meet up with the loan repayment schedule due to financial hardships, communicate your situation to your lender and make alternative repayment arrangements.

Some lenders have a hardship department that helps customers out in such situations. Your payment schedule may be varied temporarily such that your repayment can be reduced or paused till you sort out your financial hardship.

Notify your lender of the change in contact details

Before default can be listed on your credit report, the law requires your lenders to give you notice twice at your last known address. You may miss this notice due to a change of address and lose the chance to avoid loan default. That is why you should make sure your phone number and correspondence address are always updated with your lender.

Loan default is a significant financial strain that can take a while to clean off. The consequences of defaulting on debt can be long-term. As a result, you should only take out a loan if you are sure you can repay it.

Before applying for a loan, make sure to check your credit score in order to understand your eligibility and the best loan offers you can get.

With ClearScore, you can get a free credit report and check credit score in just a few clicks. Take a look.


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Written by Lloyd Smith

General Manager AU

Lloyd spreads the word about how awesome ClearScore is.