Taking a loan often seems to be easy, especially when backed with high credit scores. However, finances at times don’t work out as planned due to job losses, lost wages and emergencies. In the worst-case scenarios, defaulting on loans is usually inevitable even to the most responsible borrowers.
What is a Defaulted Loan?
A loan is said to in default whenever borrowers struggle and fail to make payments as agreed with the lender. In this case, successive payments have been missed over the course of weeks or even months. In some cases, you could be considered to be in default on missing one payment.
However, because debt collection is an expensive process, lenders tend to go slow on borrowers when just one payment is missed. Lenders and other loan servicers allow a grace period before they start penalizing borrowers on missed payments on loans.
Once one or two payments on a loan are missed, a new chain of events often comes into play, and a lender can invoke measures to try and recoup the outstanding debt. In addition, loan defaults kick start a wave of events, which in most cases affect credit scores and ultimately the wallet.
The Effects of Defaulting on Loans
Low Credit scores
Loan defaults always have a substantial and long-lasting drop on a borrower’s credit score. For starters, lenders report loan defaulters to credit bureaus, who in return lower borrower’s credit scores presenting them as high risk.
Depending on how high a credit score is and how long a loan default is, credit bureaus’ actions could considerably hurt the scores. For instance, paying a mortgage two months late could result in credit score dropping by up to 130 points and could take more than five years to recover fully.
Collateral Loss Risk
For loans secured with collateral, the lender can swing into action by seizing the assets used as collateral. For example, if you used a car as collateral, the lender can repossess it. The asset would then be auctioned, in a bid to recoup part of the outstanding debt. Some of the loans mostly backed by collateral include mortgage loans, auto loans and secured personal loans.
For unsecured personal loans, the consequences of loan defaults vary in severity depending on the loan type. In extreme cases, a lender may opt to garnish wages in a bid to recoup part of the outstanding debt. This type of action mostly affects student loans.
Impact on Loan Cosigner
Loan defaults affect not only the debtor but also the co-signer. A co-signer is simply the person who signed as a loan guarantor. In most cases, a loan default would often affect the credit score or the co-signer as much as the debtor.
Debt collectors Harassment
Debt collectors are some of the dreaded people in the loan business. Lenders often engage the services of these people in the attempt to recouping the outstanding debt. While good at their job, debt collectors are not known to be good to debtors, given the harassment they often tend to inflict
The following are the steps you can take to avoid defaulting on a loan.
Understand the loan agreement
The kind of loan agreement that a borrower enters with a lender determines a great deal how successful they will be in making timely payments. Therefore, before signing any agreement, it is important to understand the loan agreement and the type of loan on offer.
It is important to grasp the costs of getting the loan, the interest rate, as well as the repayment terms for the loan. Likewise, it is important to only borrow what one can pay and what is acceptable based on
Have Sufficient Balance
While taking a loan, it is vital to ensure there is sufficient balance that can be used to make loan payments in case something goes wrong. The idea is to have some money set aside that can be used to make loan payments in case of emergencies while awaiting a given revenue stream to come through. In this case, it is important to ensure enough headroom so that loan repayments are not missed.
A Budget Is A Must
Once you have taken a loan, focusing on making payments ought to be the priority. To do so, budget tightening ought to come into play in a bid to come up with some money that would go a long way in trimming the loan outstanding.
Living on a budget should not be seen as a means of depriving oneself of the pleasures of life. Instead, it should be living within one’s means as a way of generating some money on the side in a bid to make timely loan payments.
Contact your Loan Servicer
Making timely loan repayments can be challenging especially during harsh economic times. If that was to happen, it would be prudent to contact a loan servicer before defaulting. A loan servicer would help you understand some of the options available to avoid defaulting on loan payments.
Don’t Take Another Loan
Some people who have found themselves close to defaulting on a loan have opted to borrow elsewhere in a bid to repay another loan. Taking another loan to repay another loan amounts to a Ponzi scheme and is a dangerous game that should be avoided at all costs.
Track Debts and Ask For Help
Tracking debts is important for people who have taken more than one loan. By tracking, it becomes easy to create a single form that details each debt and what it entails. In case one is in a financial hole, seeking assistance from family members would be the right call to avert loan default.
Defaulting on a loan leads to serious consequences. The specifics vary depending on the situation leading to a slump in credit scores, repositions of collateral or garnishing of wages. Harassment by debt collectors is the last thing you can ever wish even on your worst enemy.
Likewise, if you feel you are having trouble making payments and close to a default, the best thing is to reach out to your lender in advance. While it is tough and embarrassing, it may turn out to be the best way to save oneself from the embarrassment and anguish down the road.