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What happens if you default on a personal loan?

Yahoo Personal Finance· Getty Images
Hal Bundrick
6 min read

Defaulting on a personal loan will trigger a red alert for your finances. Whatever circumstances put you into such hardship, your financial health will be at serious risk. It's worth taking some time to consider your next move.

Here's what to expect if you are about to default on a personal loan — or are trying to avoid defaulting on a personal loan debt.

A personal loan is in default when borrower nonpayment triggers a collection action and perhaps even a lawsuit by the lender. Loan payments may be 90 days or more past due when this occurs, though the lender and the original terms of the loan agreement will determine that.

Neglecting to make monthly payments and ultimately defaulting on an unsecured personal loan can set off a chain of serious consequences. Sure, most everyone is late on a payment now and then, but a looming default status means the loan is critically past due.

First, a lender will likely turn the matter over to a collections department in-house or with a third-party collection agency. You've already received prior late payment notices, maybe even certified demand letters. Now collection efforts are being kicked up a notch.

Your best path forward is to try and avoid legal action and the bad credit that would follow.

Here is how a personal loan default occurs over time.

  • 0-45 days: Most lenders allow a grace period for an occasional late payment on a loan balance.

  • 45 to 60 days: You may have started out being just a few days past due in making your monthly payment. A late fee was charged. You resolve to do better but keep falling further behind. If you're a monthly cycle in arrears, that late payment was likely reported to the credit bureaus. Your credit score may be impacted. The interest rate on your loan may rise, making payments even more difficult.

  • 61-90 days: Now you're edging closer to default status. The lender's collection efforts are stepped up. Additional late fees are mounting on your credit report. You get emails, phone calls and past-due notices from debt collectors. Your credit score is suffering even more. As a borrower in trouble, it may be an excellent time to seek credit counseling.

  • 91-120 days: Missed payments put you in the default danger zone. If you haven't already, you need to take action to avoid legal consequences. Contact the lender to attempt to work out a new repayment plan. As the debt ages — and with no action taken on your part — the lender may send the loan balance to a collection agency or law firm.

  • 121+ days: Without the matter being previously resolved, the loan is considered in default. Legal action is imminent, and you may want to seek some kind of debt settlement. Your credit score will dive, impacting your credit history for seven years or more. Wage garnishment may be next — money to repay the debt is withheld from your paycheck — or liens placed on any property you own.

Many personal loans are unsecured, meaning they do not have a valuable property, such as a house or vehicle, pledged as collateral to guarantee the debt. However, defaulting on a personal loan can still put your income, bank accounts, and property at risk.

Because the loan has no collateral, it will require legal action to obtain a judgment against you so the lender can levy cash accounts, begin wage garnishment, or put liens on your property.

Nonpayment and default on a secured loan is a much more straightforward legal path for a lender looking to collect a loan balance. The loan terms will have already set a lien on your property — a security interest in a vehicle, house, savings account, or other valuable asset that a lender can seize or sue for repossession.

Payments overdue by 30 days or more can negatively impact your credit score. A default on a personal loan means you've been persistently late in making monthly payments, and the lender has taken legal action. Even a charge-off of the debt will be a long-term blemish on your credit history and likely result in a tax bill.

Preventing a loan default should be your highest priority. Actions to consider include:

If you're falling behind on payments, be proactive. Explain your financial situation to the lender and ask for help resolving the missed payments issue, especially if you've had a change in your situation, such as the loss of a job, a reduction in hourly income or mounting medical bills.

A nonprofit credit counseling agency can help solve your debt issues and get you on track for an improved financial situation.

If you've been sued, you'll need legal advice immediately. Some attorneys may offer reduced fees or free services in debt collection matters. You may also seek help from a legal aid office where you live.

Know your rights regarding the Fair Debt Collection Practices Act and how collection agencies should treat you. The FDCPA ensures you are not harassed or verbally abused by deceptive debt collectors. You can file a complaint with the Consumer Financial Protection Bureau, your state attorney general's office, or the Federal Trade Commission if you think you've been mistreated.

Any major setback involving your creditworthiness will likely have long-term serious consequences. A defaulted loan will be a red flag to any company looking to extend your buying power, whether a credit card company, vehicle loan provider or home mortgage issuer. You'll likely be charged much higher interest rates if approved for new credit.

A co-signer's credit report will also be negatively impacted, along with their FICO score.

In the past, overzealous collection agents falsely threatened debtors with arrest and jail time. But you can only be imprisoned in a matter related to collecting a personal loan if you violate a court order or refuse to appear in court for a "debtor's examination," where you are required to testify about your financial situation.

Collections related to child support or income taxes are another matter. In those instances, nonpayment can lead to jail time.

When your personal loan is in default status, expect aggressive efforts from the lender's collections department. However, the Fair Debt Collection Practices Act prevents debt collector agents from using offensive, abusive or threatening language.

If a lender sues you for nonpayment and wins a judgment, they can place a lien on any property you own, including your home — though it is rare, and laws regarding exemptions for homestead liens vary by state. It's not a foreclosure, but you may not be able to access your home's value with a home equity loan or line of credit.

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