Here’s What Happens When You Default On A Loan

Updated: December 01, 2023 Author:

Quick answer: When you initially fail to fulfil your payment obligations on a loan, you are first given a period of grace, after which the bank can come and seize your security in the case of a secured loan or garnish your account in the case of an unsecured loan.

Default will also affect your credit score and the possibility of obtaining future loans.

    Assume you’ve taken out a bank loan with the intention of repaying it over time at regular intervals. Your loan may include a monthly repayment schedule. An unexpected emergency arises; you are unable to make your payment intervals, and your repayment plans are jeopardised. What comes next?

    We will dive into what happens when you default on a loan and what steps you should take afterwards.

    What is a loan?

    We won’t spend too long here; we’ll just cover the bases. Let’s get right to it!

    A loan refers to money borrowed from a financial institution for a given purpose that should be paid back with interest within a specific time fixed in the loan agreement.

    Now that you understand what loans are, you will need to understand what types of loans are relevant when it comes to the effect of defaulting on payment for loans.

    What types of loans are available?

    There are different types of loans available to people in the United Kingdom. Depending on the lending house or financial institution and what the loan is for, but within the discussion of default to loans, our main focus will be two types of loans.

    1. Secured loans.
    2. Unsecured loans.

    What are secured loans? Secured loans refer to loans that require collateral or assets to be given to the bank before the loan can be issued. More often than not, the value of the collateral should be equal to or more than the loan to be taken. 

    The bank granting the loan will take possession of the titled document to the asset used for collateral while you keep possession of the asset. This is done pending the time the loan will be repaid. 

    What are unsecured loans? These are loans that are not tied to any collateral. It goes without saying that these loans come with a higher interest rate and are riskier for the lender to issue. 

    Before loans of this nature are given out, the lender conducts his due diligence on the borrower to ensure they are financially stable enough to repay their loans. There is no transfer of any interest in a property, and reclaiming such loans can be tricky.

    Having understood these types of loans, there are some other terminologies concerning default on loans that you should keep in mind.

    Key terminologies you need to know.

    What other terminologies do you need to know to understand the impact of defaulting on a loan?

    Default: Default is a straightforward term that refers to being unable to meet a loan repayment schedule. While this is a fact, it is not the only meaning of the word. Default, in a technical sense, also refers to a breach of a covenant in the terms of a loan agreement.

    Delinquency: Delinquency refers to the grace period between missing your first loan payment and entering into default. You do not automatically fall into default when you miss your payment period, even if it is just a day. Depending on the class of loan given, you have a delinquency period where you can repay your loan without defaulting.

    Interest and Charges: These are the extra rates on a loan that you pay in the process of loan repayment. They are usually the profit to the lender for the loan given. More interest and charges can also be imposed on someone who defaults on their loan repayment.

    What happens when you default on certain types of loans?

    While there are more specific classes and types of loans, the categories of secured and unsecured loans serve as broad strokes for most loans. The effects of defaults under either category represent other types of loans.

    You should keep in mind that there are general effects of defaulting on a loan, irrespective of the type of loan. These effects include giving you a bad credit score, adding more charges and interest to be paid, and denting your credit file for up to six years. 

    This means the default, even when repaid, will be entered into your credit file and will stay for six years. This will affect your ability to get future loans, rent a house, and get credit cards and might even affect job prospects.

    Moving to more particular categories.

    Secured Loans: When there is a default on secured loans, the security in question can be seized or foreclosed, depending on its nature. For movable securities like cars, they can be seized by the lender. Foreclosure often comes in with fixed assets like houses or lands.

    Unsecured Loans: Since these loans have no security, banks have to find alternative means to recover the loan. Once you are in default, the loan is sent to a debt collection agency whose role is to collect the loan sum from you. This could be done by sequestration, i.e. when the bank or debt collector asks the court to declare you bankrupt. An order for wage garnishment could also be issued. This refers to the bank moving against the money in your account until the loan is repaid.

    What you should do when you are in default.

    Taking action regarding default should be done before you default on payment. Once you have identified that you will not be able to make some payments, there are certain steps you should take.

    1 – Inform your bank of the likelihood of default. More often than not, this proves your integrity and desire to fulfil the end of the loan agreement.

    2 – Renegotiate loan repayment terms. Most banks want their debtors to pay their debts, and they are willing to renegotiate repayment plans when they apply early enough. Informing your bank early enough can forestall the imposition of extra rates and charges, too.

    3 – If you are already in default, be willing to consult with an expert.

    Final thoughts on default on loans and their effect.

    Defaults can be unexpected, but they are usually not sudden. You can take the initiative to plan. This way, you can prevent emergency reactions.

    Ensuring that your loans are paid on time is the best option, but when that is not available, inform your lender on time and seek an extension of time or a revision of the loan agreement.

    FAQs

    Can you still get loans when you are in default?

    The simple answer is yes. It can be difficult getting loans when you have evidence of a default in your file, but some banks are still willing to give loans to people with defaults on their records.

    Can you get your default status removed?

    You certainly can, but there is only one condition you can rely on to get rid of a default. This condition is met if you can show the body that set the default that it was issued by error.