Falling behind on your personal loan payments can have short-term and long-term effects on your financial future. Your credit score could drop, lenders might not approve you for new loans, and you could even face legal action. If you’re already behind on your payments, there are some steps you can take to avoid or get out of default.
What constitutes a loan default?
A loan goes into default if a payment is more than 30 to 90 days late, though the number of days late varies depending on the loan and the lender. Before that, the loan is considered a delinquent account, which means you haven’t made the required payment by the due date.
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Most loan agreements have a grace period, so if you’re a few days late on a payment, it won’t immediately affect your credit. You only have to pay a late fee if you exceed the grace period. This fee varies by lender, but is usually between $25 and $50, or 3 to 5 percent of the amount you pay.
What happens if you default on your personal loan repayments?
If you default on a personal loan payment, the lender will continue to try to collect payments because you are legally obligated to pay the debt. By law, lenders must follow the Fair Debt Collection Practices Act, which limits how and when lenders can contact borrowers.
By default, this is what typically happens:
- The lender will call: Lenders can legally contact you from 8am to 9pm, seven days a week, including holidays and weekends, unless you tell them the times are inconvenient for them. Lenders cannot harass or abuse anyone in connection with collections at any time.
- Lenders will report late payments to the credit bureaus. Late loan payments can lower your score and remain on your credit report for up to seven years.
- Your account may be sold to collections: If you are 90 to 180 days late, your lender may write off your debt. This happens when the lender decides you won’t pay it back and may sell your debt to a debt collection agency. The debt collection agency may offer to work out a payment plan or settle the debt for less than what you owe.
- Creditors may take legal action: Depending on the type of loan and state laws, what could happen if you don’t repay your loan could include collections, asset seizure, wage garnishment and lawsuits.
The consequences of missing a personal loan payment can be long-term and vary depending on how many payments you’ve missed. In most cases, you can expect the following consequences:
- Your credit score may be affected by: Your payment history plays a big role in your credit score, so defaulting on a debt can significantly lower your score.
- Your access to credit may be limited: Some lenders may reject your future loan application or approve you for a much smaller loan amount.
- Interest rates may be higher in the future. If your credit score drops significantly, you may not be able to get the best interest rates when applying for other credit products.
What to do if you are at risk of defaulting
If you think you can’t continue making payments on your personal loan, it’s important to act quickly: notify your lender and look for alternatives to defaulting.
Look at your financial situation
First, get a clear picture of your financial situation and find out why you are unable to make your loan payments. Check your budget, compare your current services and even look for additional income opportunities.
- Review unnecessary spending in your budget and see where you can make changes. Consider preparing more meals at home and canceling subscription services you rarely use.
- Compare rates for services like home internet, auto insurance, home insurance, and renters insurance to see if you can get a better deal with another provider.
- Consider a part-time side hustle to boost your monthly income. Even an extra $50 a week could help you avoid missing a personal loan payment.
Contact the lender
Be proactive and contact your lender to discuss the situation before you fall behind on a payment. If you’re experiencing a temporary problem, like an unexpected car repair or an expense that’s drained your savings, let your lender know.
If it’s a long-term issue, like losing your job, let your lender know. They may be willing to offer you flexible payment options if they see you’re still committed to paying off your debt.
Inquire about a loan modification
A loan modification allows you to establish new repayment terms for your loan. Your lender might pause payments, spread your payments over a longer period of time, or allow you to add missed payments to your loan balance so you can pay them later.
While these options may increase the total cost of your loan, loan modifications can provide you with much-needed short-term relief.
Debt consolidation investigation
If you’re struggling to pay off high-interest debt, consider a debt consolidation loan. Personal loan interest rates are often lower than credit card interest rates, and consolidating your payments and interest into one can give you more room in your budget and help you avoid defaulting.
Find a debt counselor
If you’re not sure where to start, meeting with a credit counselor may help you zero in on what to do next. Look for a counselor who works for an accredited nonprofit organization. They can review your budget and guide you by discussing different options based on their expertise.
They may be able to help you renegotiate your plan with your lender, create an affordable debt management plan, and offer strategies to improve your credit after defaulting.
Consider debt relief
Using a debt relief company is another option for lowering your payments. These companies work with creditors to create more affordable payment plans and charge a fee once the plan is approved.
However, debt relief companies will usually ask you to stop making payments on your debt so that your lender will cooperate, which can further damage your credit score. If you don’t want to work with a company, you can also negotiate with your creditors on your own.
How to avoid defaulting on a personal loan
To avoid the risk of defaulting on your personal loan repayments, consider these strategies:
Choose the right loan terms
Before taking out a loan, honestly consider your income, monthly debts, and spending habits. If your income fluctuates from tips, commissions, or self-employment, a personal loan may not be the best choice. If you’re already living payday to payday, you may want to wait until you can afford the additional payments.
Make sure you fully understand the loan terms, including interest rates, monthly payments, and repayment term.
One downside to a personal loan is that your monthly payments are fixed. If you don’t need the full amount at once or you need the flexibility to make minimum payments when your income is low, a credit card or line of credit may be a better choice. On the other hand, credit cards often have higher interest rates, and unlike the fixed interest rate on a personal loan, your card’s interest rate can increase.
Set up automatic payments
When life gets busy, it’s easy to overlook a bill. Autopay helps ensure you don’t forget and miss a payment. You may even qualify for an interest rate discount when you set up autopay. Make sure you have enough funds in your account on the due date to avoid overdraft fees.
Conclusion
Defaulting on loan repayments can have a negative impact on your finances for years to come. Before applying for a loan or any kind of debt, review your budget to ensure you can afford the payments.
If you’re on the verge of defaulting on your loan payments or have already missed a payment, you always have options. The earlier and more frequently you communicate with your lender, the better your chances of avoiding the consequences of serious loan default.
