How does a loan default affect your credit?

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

Most people do their best to keep up with all their payments, but loan defaults can happen. Things like unexpected expenses and job loss can make it challenging to keep up with payments that were manageable before. 

When a loan default happens, it’s best to face it head-on and plan what to do next. Unfortunately, a loan default can have a significant impact on your credit. Understanding exactly what this impact will be—and how you can handle it—can help you get back on track with both your finances and your credit. 

What is a loan default?

A person defaults on a loan when they fail to make their payment (both interest and principal) as agreed to in the loan contract. 

When you stop making payments on your loan, your loan is considered “delinquent.” After a certain period of delinquency—usually between 30 and 270 days—the loan is updated to “default” status. At this point, the lender assumes you have no intention of paying back your loan. 

Consumers should do everything they can to avoid a loan default. It can have negative consequences on a person’s credit and finances, including credit score damage, the debt being sent to collections, the possibility of a wage garnishment and even a lawsuit. 

You’ll need to know your lender’s specific past-due payment deadlines when your loan is in jeopardy of going into default. With some lenders, this can happen after just one missed payment, while with others, it can take several months of missed payments. You typically know you’ve gone into default when your loan repayment status is updated to default. Additionally, you may notice that your credit report now has a line item for the defaulted loan. 

Loan default by loan type

How the loan default process works varies depending on the type of loan and the lender. For example, some (but not all) lenders offer a grace period. This is the additional time a lender gives a borrower to make a payment before penalizing them with further action. This turns a potential missed payment into a late payment instead. 

Keep reading to learn how the typical loan default process works for each type of loan.

Auto loans

Most auto loans go into default after just 30 days of missed payments. Some auto loans come with grace periods, but this varies greatly from lender to lender. 

Auto loans are secured loans, with the vehicle acting as the collateral. This means when you go into a loan default, your lender may repossess your car. The lender will then sell your car at an auction, and you’ll be responsible for any outstanding balance.

However, many auto lenders don’t like to rush into repossession. Vehicles depreciate over time, so even repossessing and selling the car usually won’t get the lender the full amount of the loan balance back. As a result, auto lenders are often willing to work with borrowers on a repayment plan to avoid repossession. 

Mortgages

Like auto loans, mortgages are secured loans, with the home acting as the collateral. Most mortgages go into default after 60 days of missed payments. The lender may choose to foreclose on the house to recoup their losses. If the sale doesn’t cover the full balance of the outstanding mortgage, the borrower will have to pay the difference. 

Most mortgage lenders offer a 15-day grace period to make up a payment after the payment deadline passes. 

Student loans

The loan default process differs depending on whether you have a private or federal student loan. Most private student loan lenders default 90 days after the first missed payment, and your grace period will vary depending on your lender. 

In comparison, individuals with a federal student loan get more leeway, with the loan going into default 270 days after the first missed payment. Federal student loans have a 90-day grace period. 

Student loans are unsecured loans, so lenders don’t have an asset they can seize to get their money back. Instead, they have to pursue alternative methods. Private student loan lenders can file a lawsuit in an attempt to recoup their losses. If you hold a federal student loan, the lender doesn’t have to take you to court. Your wages can be garnished and tax refunds withheld after a certain period of your loan being in default. 

Credit cards

You typically have 180 days from your first missed payment before your credit card goes into default. The grace period is often one missed payment before any penalty occurs. 

Credit cards are another type of unsecured debt, so lenders will often resort to filing a lawsuit to get their money back. They may try to pursue wage garnishment in court. 

Other loans

Other loans, such as business loans and personal loans, typically have only 30 days from the last payment before the loan is considered to be in default. The grace period will depend on the lender. 

Your business loan or personal loan may be secured or unsecured. If it’s a secured loan, the lender can confiscate your assets to recoup payment. On the other hand, an unsecured loan will often lead to a lawsuit for wage garnishment. 

How to avoid a loan default

Don’t assume a loan default is your only option. Depending on the type of loan you have, you may be able to look into loan modifications. For example, student loans have deferment and forbearance options that temporarily allow you to stop payments. And mortgage lenders offer options such as refinancing to a longer loan payment term so you can reduce your monthly payments to a more affordable amount. 

Even if a loan modification isn’t possible, generally, you should always communicate with your lender as soon as you think you might not be able to make payments. Many lenders don’t want to go through the process of lawsuits or collateral repossession, so they have procedures set in place to work with you.  

Additionally, you could also look into consolidating debt or refinancing. These options might allow you to bring your debt down to a new monthly payment that’s more in line with your financial situation. 

What to do if your loan is in default

If your loan is already in default, it’s not too late to try to make things better. There are specific programs in place for student loans that help with loan rehabilitation. And for other kinds of loans, you can try to negotiate a repayment plan with your creditor to get caught up on your past-due amounts as soon as possible. As we mentioned above, most creditors want to work with you and will do what they can, within reason, to help you get back on track. 

Lastly, make sure to check your credit regularly to see how things are being reported to the bureaus. A loan default will impact your credit, knocking your score down and affecting your credit for potentially up to seven years. The good news is that you can be proactive and take steps to fight this negative impact on your credit. By creating responsible financial habits, you can get your credit back to a healthy place.

Not sure where to start when it comes to repairing your credit? The credit consultants at Lexington Law Firm could help. Our team can work with you to review your credit and file disputes if any errors are found, as well as provide you with credit education. Your loan default doesn’t have to impact you forever—you just have to take steps to make a change today.

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