You could be subject to severe consequences depending on which type of loan you default on. These can include a damaged credit score, asset seizure and possible legal action. These are the most common consequences for loan default:
Credit score damage: No matter the type of loan that you default on, there will almost always be a long-lasting and serious impact on your credit score. Your payment history is 35% of credit score. A default can remain on credit reports for up to seven year. This could make it more difficult to get credit in the future.
Seizure of assets: If you fail to pay a secured loan, which is backed by collateral, the lender can take the collateral asset and sell it to recover the amount. Mortgages that use your home as collateral and auto loans that use your vehicle to secure the loan are two examples of common secured loans. Your house can also be used to secure loans such as home equity loans or HELOCs. Personal loans can also be secured. The exact collateral required will vary from lender to lender. It can be devastating to lose your car or home, so it is important that you avoid defaulting on secured loans.
Legal action: Your creditor may take you to court if you default on a loan. Although the exact process will depend on your state’s laws, a creditor may be able collect your personal assets and garnish your wages if they can get a court order.
Wage garnishment: Federal student loans are not like other types of debt. Creditors must get a court order to garnish your wages. The federal government can take up to 15% of your income and garnish your wages if you default on federal student loans. Lins also says that the government can do a Treasury offset. This means it takes money from your social security benefits or tax refund to pay your debt.
How to get out of default
- Contact your lender
Contact your lender immediately if you think you will not be able to make loan payments. Let your lender know about your situation to help you negotiate a payment plan. Many lenders will work with you to find a solution, before you default.
Lewis-Parks states that lenders are willing to work with people, especially in this current economic environment. “So consumers shouldn’t be afraid of reaching out. It won’t make things worse.”
Talk to your lender if you are behind on your mortgage payments. A forbearance agreement allows the lender to allow you to lower or stop your monthly payments for a set period of time. You could also work with a lender to modify the terms of your loan in order to lower your monthly payments.
- Consolidate or rehab federal student loans
Rehabilitation and consolidation are the two main methods to avoid defaulting on federal student loans.
You’ll be able to work out a new repayment schedule with your loan provider based on your discretionary income. Your loan will no longer be in default after nine monthly on-time payments as part of a rehabilitation agreement. The default record will be removed from credit reports.
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Loan consolidation allows for you to consolidate federal loans that are in default into one new Direct Consolidation Loan. The new loan can then be repaid under an income-driven repayment schedule.
The third option is to pay off your defaulted loan completely, although this is less common. While this is unlikely to be possible for most borrowers it might be possible for those who have previously defaulted but have received an unexpected windfall that allows them to repay the loan in full.
- If you are in need of help, it is worth seeking it
A non-profit credit counseling agency or housing agency can help you if you feel overwhelmed by your debt. A counselor can help you evaluate your options, strategize your debt and negotiate with creditors.
Lins says, “One of our main tasks is to help consumers break the cycle of inaction and understand their choices, help them make plans, and move forward.”
Although some credit counseling agencies may charge a fee, it is usually waived for those who are experiencing financial hardship.
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A housing counseling agency provides guidance on housing, including foreclosure and mortgage default. However, a credit counseling agency can help with all types of debt from student loans to personal loans to credit cards.