Missing a payment on a loan may not seem like a big deal at first, but missing a loan payment may lead to fees and a damaged credit score. Whether you have an auto loan, mortgage, student loan or personal loan, knowing what delinquency and default are in finance is essential in understanding how they could affect your credit and financial wellness in the future.
Ron VanSkiver, assistant vice president of retail financial services at Centris Federal Credit Union, gives his expertise on delinquent debt and defaulted accounts and his best practices to help avoid overdue payments before they become a problem.
Delinquency vs Default: What’s the Difference?
- Delinquency is when a borrower fails to make an on-time payment on their loan. Usually, a loan or account is considered delinquent when a borrower misses one payment.
- Default typically occurs when delinquency continues over an extended period. So, when a borrower continues to miss payments, the account will eventually go into default. When a loan goes into default depends on the type of loan and terms.
The terms delinquent and default are used together often because one may lead to the other.
What Happens When a Loan is Delinquent?
When a loan becomes delinquent, here’s what may happen.
Most lenders will charge a penalty, such as a late fee, a couple of days or one week into your delinquent loan. Delinquency fees typically range from $25-50 for flat fees or 3-5% of the unpaid amount. You can typically find the exact rate of your loan’s late fees by checking your loan terms.
You have about 30 days to resolve your delinquency. Once 30 days past due, your late payment gets reported to the credit bureaus. According to VanSkiver, payment history is the largest component of every credit scoring model. That means making on-time payments is a key factor in your ability to borrow money. For example, payment history makes up 41% of your VantageScore, so once that delinquent payment is reported to the credit bureaus, your credit score could dip significantly, depending on your score. And, once it’s on your credit report, delinquent credit cannot be removed and will remain there for up to seven years, even if you pay the past-due balance.
However, fixing delinquency on credit reports is often easier to fix than default. If your loan becomes delinquent, it’s important to bring the loan current. To do this, you’ll have to make all past-due payments and pay any late fees associated with the account. By doing so, you may avoid default and perhaps be able to work with the lender to make a repayment schedule that will work for you.
What Happens When a Loan is in Default?
After several missed payments, a loan may move beyond delinquency status and go into default.
Once a delinquent account defaults, the typical installment payments end, and the entire loan balance is due in full. The lender either tasks their in-house collections department or a third-party debt collector to attempt to recover the debt by calling you or sending you letters or emails.
Having a loan in default severely hurts your credit. Like late payments, a reported default will remain on your credit score for up to seven years. Because default indicates that you are behind on payments or stopped making payments, it can be very difficult to get additional loans or funding from other lenders.
If the loan is secured with collateral, such as a vehicle or real estate, at some point, the lender may exercise their rights under the loan agreement to repossess or foreclose on the asset so that it may be sold to cover the loan obligation. “Repossession and foreclosure actions are not made lightly and are usually only done if there appears to be no other viable path to repayment,” emphasizes VanSkiver. If there is still a delinquency balance owed after the repossessed or foreclosed collateral is sold, the lender may pursue other legal options for repayment, such as garnishing wages.
If a cosigner is on the defaulted loan, it is as much their responsibility to pay back the money as the primary borrower’s. This means that a defaulted loan may affect the cosigner’s credit score as much as the primary borrower’s.
Steps You Can Take to Prevent Delinquent & Default Loans
Delinquent bills or default may happen due to unforeseen circumstances, such as job loss or a costly emergency. A credit card may be a viable short-term solution to cover unexpected costs and allow you to make your loan payments. However, that solution isn’t always right for everyone, and it’s still important to know what to do before and during loan delinquency to help avoid default.
Create a Budget
If you do not yet have a budget, it may be time to create one! Knowing where your money comes and goes each month will help you better understand your finances. Plus, when you’re considering borrowing money, a budget can help you determine if you’ll be able to afford the monthly loan payments. You can create a budget in an online budgeting calculator, app or other avenue that works for you.
If you see on paper that you’d be able to make the payment, but want to be sure, VanSkiver recommends you “try it on for size.” Start by setting aside the same amount of money needed to cover the monthly loan payments into a savings account. If you see that this stresses your budget quite a bit after a few months, you might want to reevaluate borrowing that money or make changes to your spending habits so you can make those payments comfortably.
When deciding whether you should take on another debt payment, also consider your savings. Do you have a good emergency fund built up? If not, consider putting money toward that instead of the debt, if realistic.
Use Automatic Payments
Life moves fast and it’s easy to forget things sometimes! That’s why VanSkiver recommends using automatic payments from a primary checking or savings account which has regular deposits that can be used to pay your loan. This ensures against forgetting to make a timely payment, which in turn, protects your credit score. Plus, some lenders give interest rate discounts if you set up automatic payments with the loan.
Communicate with Your Lender
If it’s getting down to the wire and you know you’ll miss your loan payment, reach out to your lender instead of going MIA. Reputable lenders may be able to offer you the option to defer payment for a month or allow you to make interest-only payments for a short time. Not all loans qualify for the same modifications, so ideally, you would check into these options before your loan becomes delinquent.
VanSkiver notes reputable lenders are interested in building long-term relationships with borrowers. They would not wish to see people put into difficult financial situations like delinquency or default. Keeping an open line of communication with your lender may help you. The longer you wait to ask, the fewer options you may have.
Look into Debt Consolidation
Having multiple loans or credit card payments to keep track of can be stressful. If you often find yourself forgetting payments or want an easier way to manage your loans, debt consolidation may be right for you. Debt consolidation is a way to merge your debts by taking out a new loan or credit card, leaving you with a single monthly payment. Debt consolidation may not be the right choice for everyone, but it is an option.
Speak with an Expert
Getting help sooner rather than later could save you stress, time and money.
However, VanSkiver cautions you to be wary of credit counselors or advisors offering you a quick fix to credit problems or offering to make the payments for you. Reputable credit counselors are trained in credit issues, money and debt management and budgeting, and they will want to get an idea of your entire financial situation before making a personalized plan for you. Most reputable credit counseling programs are non-profits with lower fees and are often found at credit unions, universities or U.S. Cooperative Extension Services branches. At Centris, we offer financial counseling services through GreenPath Financial Wellness for our members.
Loan delinquency and default are topics to take seriously, and while we can’t prevent unforeseen circumstances from taking a hit on our finances, we can work to prevent the consequences of delinquency and default.
