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What happens when you default on a loan?

What it means to default, how to avoid it and what to do to get back on track.

Defaulting on a personal loan may be expensive and can do some severe damage to your credit. However, being informed can help you get back on the path to financial wellness. We break down what happens when you default on a loan, the consequences and what to do if you’re struggling to meet your repayments.

When is a personal loan considered in default?

It depends on your loan type, lender and the terms of your specific term agreement. Many contracts consider your loan to be in default 30 days after you miss a repayment, however, you are likely to be charged a late payment fee or direct debit dishonour fee. These fees could be as much as $10 when you miss a payment, and another $20 if the payment hasn’t been made within 5 days.

Under the Credit Contract and Consumer Finance Act, default fees must be $30 or less.

A lender may not report a repayment as late to a credit bureau until around 30 days after it was due, which means most of the time, a payment that is late for a period of up to 30 days won’t hurt your credit score. To know your loan’s specific terms for default, check your loan contract or contact your lender.

What happens if I miss one payment?

Your loan won’t necessarily be in default if you’re late and you might not even have to pay a fee. Many lenders offer a grace period before a late payment charge kicks in, typically around five days. This gives you a chance to put things right, since missing a payment may not be intentional. It could be a result of your salary or wages coming into your account a day or two late.

After that, the lender requires you to pay a fee. The fee may be expressed as a percentage of the repayment due, or it is a fixed dollar rate. Some lenders also charge extra interest, instead of a fee.

If your loan repayments are made by direct debit and you don’t have enough money in your account on the due date, your bank can choose to dishonour the payment or allow the transaction to go through. A dishonoured payment usually incurs a charge by your lender, and if the transaction goes through and your account is in the red, your bank may charge you unarranged overdraft fees.

What happens when you default on a loan?

A personal loan default can affect your life in several different ways. Many people start getting phone calls from debt collectors after they default, and some even face legal action from their lender. Here are five things that can happen if you don’t make a repayment within 30 days of its due date.

1. Additional fees

For each repayment you miss, the lender charges you for a late payment. This could be straight away, or in many cases, after five days. Each time your lender unsuccessfully attempts to withdraw from your bank account, you have to pay a direct debit dishonour or insufficient funds fee.

You may also be charged default interest for the period of time you are in default. You can only be charged default interest on the amount that is in default.

2. Lower credit score

Your repayment history is one of the most critical factors in your credit score. Even missing one repayment can lower your score and go on your credit report. Defaults can stay on your credit report for up to five years.

3. Harder to qualify for future credit

Having a default on your credit report tells a lender that you haven’t always honoured your contracts and might not be creditworthy. Many reputable lenders won’t work with anyone who has a recent default on their file. Even if a lender does offer you a loan, having a bad mark on your credit report makes it difficult to qualify for competitive rates on loans, credit cards, mortgages, car loans and other types of finance.

4. Lose collateral

Thought you’d save on interest by taking out a secured loan? If you used your car or another asset as collateral, your lender can send a debt collection agency to repossess it.

This won’t happen if you miss one payment and are able to get back on track within a reasonable time frame agreed with the lender. If you are not keeping up with your payments, the lender must issue a written notice with 15 days advance warning to pay the money you owe – however, there are some expectations to this regulation.

Your asset may be repossessed after the 15 days warning if you haven’t made an effort to fix the situation. Once the item is collected, the lender can sell it after 15 days if you still haven’t settled your account arrears. You can find out more information about how this process works on the Consumer Protection website.

5. Garnished wages

Your lender can attempt to get a court order to garnish your wages. If it’s successful, it takes funds directly from your paychecks until you pay off the loan plus any interest.

Worried you might default on your loan? Here’s how to avoid it

Fortunately, there are steps you can take to prevent your credit from going into default. If you think you’re going to miss the next repayment, you might want to do some or all of the following:

  • Contact your lender. Calling or visiting your lender in person might be the fastest way to alert your lender that you may have trouble making a repayment. Many are willing to work with borrowers that think they might default by adjusting your loan term to lower your repayments. They may be willing to take other steps if you’ve found yourself in financial hardship.
  • Ask your family and friends. In times like these, your social safety net might come in handy. Explain the situation to a relative you trust and ask if they can help you out with a family loan.
  • Talk to your employer. Some companies might be willing to give you a pay advance if you’re in a tight spot with a lender. Ask your human resources department about your employer’s policy for advances.
  • Talk to a credit counselling service. Struggling with your finances and worried about what happens when you default on a loan? Visiting or talking to a credit counselling service might help you get back on track and think of strategies to avoid missing repayments. The Citizens Advice Bureau has branches around the country or you can call MoneyTalks, a free budget and financial hardship helpline.

Already in default? Here’s what to do next

The sooner you can get out of default, the faster you can start to build your credit. While that negative mark stays on your credit report for five years, you can begin taking steps to regain your financial health right away.

  • Pay your late payment and fees. Just missed the cutoff for late payments? Try to pay off the late payment and fee before it goes to collections. If you sit on it too long, your lender could sue you for repayment or get a legal judgment to garnish your wages.
  • Speak to your lender. If you are struggling to meet your repayments, for example, if you’ve lost your job due to illness or injury, you may be able to restructure your loan. This could mean reducing the payments and extending the loan term so that it’s more manageable for your current situation.
  • Negotiate a settlement. Has your lender already called in a debt collector? You might be able to negotiate to reduce your debt to a large one-time payment. You can do this on your own or hire a debt management company, but make sure you’re working with a reputable organisation.
  • Get credit counselling. Credit counselling can also help after you default on your loan, by helping you come up with a plan for paying off and staying out of debt.

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