What Does It Mean to Default on a Loan — and What Are Your Legal Options?

How long do you need to be behind on your payments to default on a loan? The answer to this question varies based on several factors, but it’s important to take the steps you need to catch up.

This guide reviews how loan default works and what you should do next.

Sometimes, people are unable to make their loan payments on time, but the good news is that most lenders provide grace periods to give borrowers an opportunity to avoid defaulting on the loan. To default on a loan means to violate the initial agreement, usually by missing payments. This may allow the lender to take action to collect the outstanding debt or take back possession of the property.

The actions the lender might take depend greatly on the type of loan. Lenders may note late payments on your credit report or send the debt to a collection agency. The lender might also cancel your loan. For example, a bank might cancel your credit card and refuse to lend you any additional money.

If you have a secured loan, the loan is backed by collateral, such as a home or a car. The lender can repossess a vehicle or foreclose on your home to recover the money lost due to a loan default. It can be expensive to go through this process, however, so most lenders want to find a way to keep you making your regular monthly payments.

What Is a Grace Period?

You may be able to avoid default on a loan if you pay within a grace period. If your monthly payment is due on the 5th, for example, you might be able to make your payment on the 12th and avoid terminating the contract. There may be late payment penalties, but paying those fees can help you avoid having your account sent into collections or your property repossessed. Here are typical grace periods based on different types of loans:

• Student loans: 90 days
• Auto loans: Varies by lender
• Credit cards: Late payment fees begin after the first missed payment
• Mortgages: 15 days

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When Does the Loan Go Into Default?

Grace periods are simply the amount of time that you have to make a payment before the lender demands action against your account. After your grace period is over, the lender will demand that you make up all your missed payments and pay any late fees before the loan goes into default. Just as with grace periods, the amount of time that must pass before defaulting on a loan varies by the type of loan:

• Student loans: 270 days
• Auto loans: Varies by lender
• Credit cards: 180 days
• Mortgages: 30 days

What Steps Should You Take Next?

Defaulting on a loan can have long-lasting consequences, so you want to do everything in your power to work with your lender to settle the matter. The first step you should take is to contact your lender directly and find out if they’re willing to work with you so that you can catch up on your payments. If you’re able to pay all your late payments, the lender may reinstate your loan.

Another option is to try to consolidate your debt with a debt consolidation service. If you owe money on multiple credit cards, you may be able to roll all your debt into a single loan at an interest rate that’s much more manageable for you. If you’re late on your mortgage and have a good past payment history, you might be able to restructure your mortgage if you explain to the lender that you’ve fallen on hard times.

Auto lenders are likely to restructure the term of their loans with you if you act quickly. The expense of repossessing a vehicle and selling it at a depreciated value makes it more advantageous for them to allow you to continue making your payments. Call the auto lender right away and try to settle the missed payments under a restructured arrangement.

People trying to avoid defaulting on their student loans may qualify for special loan rehabilitation programs that allow them to pay back the loan with a portion of their current income.

Consequences of Default

In addition to damaging your credit score, you face numerous legal challenges after defaulting on a loan. Lenders may be able to attempt to garnish your wages, student loan debt can be withheld from your tax refunds and you could lose your home or car. It also becomes more difficult to obtain financing in the future if you’ve defaulted on past loans, and new loans will cost more in interest until your credit score improves.

What Are Your Legal Options?

One of the tactics lenders may use to collect the debt you owe is to take you to court. This is so they can receive a settlement in court that binds you to the debt. Most people never show up to the hearings, so the lender uses this as leverage when they send a debt collection agency after you. If you’re behind in your payments, you have rights under the Fair Debt Collection Practices Act.

Lenders can’t threaten, deceive or harass you when attempting to collect on their debts, so if you’re being treated in a manner you believe is illegal, contact an attorney to discuss your rights. In some cases, if a debt collection agency breaks the law, you may be able to earn a settlement from that company.

The Bottom Line

If you’ve fallen behind on your loan payments, there are plenty of things you can do to avoid defaulting on the loan. Try to work with your lender, know your rights and consider your legal options. You may be able to consolidate or restructure your debt to avoid default.