Straight Talk About Loan Defaults

 
 
 

This is a bit of a heavy topic but it’s one that we can’t ignore.  Life can rough us up sometimes and things just don’t go the way we thought.  Or maybe we entered into a loan agreement not fully understanding it or what was expected of us. 

So even though this topic can be thought of as negative, what if we flip make it about knowledge.  It’s about being informed because that’s the first step in making better choices. 

So, let’s get right into it!

First things first, let’s talk about what it really means to default on a loan. When you take out a loan, whether it's for a car, a home, or a personal loan, you are entering into a legal binding agreement to make regular payments towards that loan over time. These payments will typically cover both the principal, which is the original amount you borrowed, and the interest, which is essentially the cost of borrowing the money.

Sometimes life happens like a job loss, sudden and unexpected medical bills, or simply tough times.  We all miss one payment now and again, but when you miss one, it’s considered what’s called a delinquency.  When you continue to miss payments for an extended period of time, like 90 or even 180 days, that’s when most likely you’ve officially entered default territory.

 

Defaulting on a loan technically & legally means you’ve broken your agreement with the lender.  At this point, the lender now has the legal right to take action to recover the money you owe. This could involve sending your debt to collections, taking legal action, or even repossessing the asset you borrowed the money to purchase—like a car or a house.

When you default, it’s not just between you and the lender anymore. That information gets reported to the credit bureaus, and then it impacts your credit score, and it can be a significant impact.

This process can happen faster than you might think.  Depending on your state laws and the terms of your loan agreement, repossession can happen after just one or two missed payments.  It is our experience that lenders will try to work with you as long as they can before they take that step.  The truth is, they don’t want something like a repossession to happen any more than you do.  They want a positive outcome for you. 

Unfortunately, once it’s gotten to that point and they start the repossession process, there’s often little you can do to stop it unless maybe you can pay the outstanding amount or try to work out a payment plan.  Once it’s gotten to this point, it’s most likely been going on for quite some time and its what the lender has to do. 

Many people assume that once the car or house is gone, their debt is wiped out. Unfortunately, that’s usually not the case. Often, after the repossession, the lender will sell the item in an attempt recover the money owed.  The rub here is that, often the items value is not enough to recover the total debt.  The difference in the debt and the amount recovered in the sale is called a “deficiency balance.”  If that amount isn’t paid, there can still be further collections efforts and of course, it will show up when you try to get other loans or credit. 

To take this a little further, your credit score and the information on your credit report is essentially a snapshot of your financial reliability.  It’s a number that lenders, landlords, even some employers will use to determine if you’re a good financial risk.  Things like missing payments, defaulting on loans, and repossession are things that hurt your credit score—and they hurt it a lot.

What do I mean?

  1. Lets start with Missed Payments: Missed payments get reported to the credit bureaus— those are Experian, Equifax, and TransUnion. Late payments can stay on your credit report for up to two years.  In fact, just one late payment can drop your score by as much as 60 points. Payment history is 35% of your credit score and quite frankly, it’s just a big deal.

  2. Next is the Loan Default: When you default, lenders see that and it will cause your score to drop even further.  A default will stay on your credit report for seven years from the date of the first missed payment.  Even if you clear it up, it stays on the report.  A future lender can see that you cleared it up, which is good and could help their risk assessment, but it won’t erase from your history.    

  3. Last is Repossession: This is the big one. If your car or home is repossessed, it shows that not only did you stop making payments, but that the lender had to take the drastic step of reclaiming the asset to recover their money. So, not only will it drop your score substantially, like the default, it can stay on your credit report for seven years.  Lenders who see this will consider it big risk factor.  Again, paying it off or settling that debt will help and may help you get approved for a loan in the future but the risk will most likely still be considered high.  

 

The thing many people don’t realize is having poor credit can impact many aspects of your financial life. It goes beyond having a harder time getting approved for loans and having higher  interest rates. A poor score can also affect your ability to rent an apartment, for some employers it can affect you getting a job or even something that seems simple like getting a cell phone plan.

 

Now, let’s talk about the silver lining: how you can avoid getting to that point.

  1. Talk to Your Lender Early: If you know you’re going to have trouble making a payment, don’t wait. Contact your lender as soon as possible. They often have programs in place to help, whether it’s a temporary deferment, a modified payment plan, or even refinancing options.  Ask!  Let’s find a solution before its gets out of hand.

  2. Create a Budget: Take a good, hard look at your finances. If you’re struggling to make payments, a budget can help you find areas where you can cut back or reallocate funds. Sometimes small changes can make a big difference.  Sometimes they are hard choices but if it’s gotten to this point, we have to be honest… it’s time. 

  3. Ask for help: If your financial problems feel overwhelming, don’t be afraid to ask for help.  Get help making a budget or looking at your finances.  Sometimes when you’re in the situation, it’s hard to step back and see what you need to see and someone else may be able to make suggestions you didn’t see.  There are nonprofit organizations that offer free or low-cost services to help.  First Pioneers has financial counselors on staff that will be glad to help.  Truthfully, this could even include speaking to a counselor to work on things like your relationship with money or your mindset.  Financial stress can have huge impacts on you mentally and physically.  So, no matter what help you need… find it!

  4. Build an Emergency Fund: Life happens, and having a financial cushion can help you avoid missing payments. Even setting aside a small amount each month can help cover unexpected expenses down the road. Do what you can.  You would be surprised how much even a small amount can get you over a hump when you need it.

At the end of the day, no one sets out to default on a loan or have their car repossessed. Most people enter a loan with good intentions and will work to make their loan payments.  But life doesn’t always go according to plan, and sometimes things happen that are out of our control.

The good news is there are things you can do to help yourself.  There are programs that will help you rebuild your credit if you need to.  There are ways to get you back on solid financial ground.

Remember, your credit score is just one part of your financial picture, and admittedly, while defaulting on a loan or facing repossession can feel like a major setback, it’s not the end.  A little time, and effort, and the right tools, you can absolutely recover.

Bonus Tip:

The Power of Communication

One of the biggest mistakes people make when they're struggling financially is avoiding the problem.  It’s easy to feel overwhelmed or embarrassed, or your find yourself just ignoring it, hoping it will get better.  It’s hard to admit that things have gotten out of hand or that you don’t understand something. That is just human!

But the truth is, most lenders would much rather work with you than see you default or face repossession. If you find yourself falling behind on payments, reach out before things get too far gone.

Even if you're just a month behind, a quick phone call to your lender can open the door to options you may not know you have.

There may be a loan restructure option or a temporary payment deferral, or even as far as refinancing your loan. The only time there is no solution is when we don’t ask or look for it.

It may not be the solution you really want, but sometimes we have to realize that in order to get where we want to be we have to make hard choices and do hard things.  The good news is, we can do hard things!  How often have we seen that success is on the other side of a hard decision or hard action? The place to start is communication.

We hope this information helps and gives you clarity on what it really means to default on a loan, how repossession impacts your credit, and—most importantly—how you can avoid these situations in the first place.

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Heather Hargrave