How Defaulting on a Loan Affects Your Credit
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Loans can be a useful tool for meeting your financial obligations and building your credit score — if you manage them well. But if you find yourself unable to keep up with your loan payments, you could end up damaging your credit and crippling your long-term financial prospects.
Defaulting on a loan can cause a major dip in your credit score, which will then hurt your ability to get a mortgage, a good insurance rate or even a job. Defaulting on a mortgage may result in foreclose on your home. Your car can be repossessed if you default on an auto loan. And if you default on your student loan, you may risk having your wages garnished or a tax refund withheld.
Here’s a step-by-step guide to what happens to your credit when you fail to make your loan payments.
- How late payments affect your credit score
- Avoiding a loan default
- Bottom line
How late payments affect your credit score
Your payment history is the single most influential factor when calculating your credit score. When you make late payments on your loan, or go into default, your payment history takes a hit. The later your payment, the more severe the impact will be on your credit score. When it comes to keeping your credit score out of the basement, you can’t be too careful about avoiding late or missed payments.
The good news is, if you make a payment less than a month late, you are probably in the clear. Lenders typically give borrowers a 30-day grace period before reporting late payments to the credit bureaus.
If you can’t pay within 30 days, call your lender as soon as possible to negotiate your payment. Some lenders may be willing to work with you to either settle a debt or set up a repayment plan that won’t ding your credit.
30 days late
If a payment is more than 30 days past due, your lender will most likely report the missed payment to the credit bureaus, and your credit will take a hit.
A 30-day delinquency could cause a drop of 60 to 110 points on your credit score, according to FICO. And the higher your credit score, the bigger drop you can expect. This is because a high score probably showed no previous delinquency, whereas a low score probably already reflected some negative behavior. Think of it like a car: A large dent on an otherwise spotless sports car could seriously hurt its value, whereas one more dent on a beat-up old jalopy won’t matter much.
A late payment can remain on your credit report for seven years. So, if you had a single late payment in January 2019, that late payment mark won’t fall off your report until January 2026.
30-90 days late
If you fail to pay your debt for 30 to 90 days, that means you may have missed more than one payment, and your lender will likely send the debt into collections internally. During this period, the creditor will use its in-house collections team to try getting you to repay the debt by calling you or sending letters. You can expect your credit score to slip further.
180 days late
Once your payment is 180 days past due, your creditor will most likely charge-off your account or sell your debt to a third-party debt collector. Charging-off means the creditor no longer expects you to pay back your debt and has written off your account as a loss.
From this point on, you are probably no longer dealing with your original creditor because your debt now belongs to a collection agency. You can expect the collection agency to aggressively and frequently use a variety of tactics to get you to pay your debt, including phone calls, letters, emails and social media messages.
A charge-off will also result in a new negative mark on your credit report, which will continue to drag your credit score down. Worse, an account that goes to collections — unlike one on which you are simply late — cannot be made current again by making regular payments. So, it’s advisable to do what you can to keep your account from ever becoming a charge-off.
A collections account can remain on your credit report for up to seven years plus 180 days from the delinquency date that immediately preceded collection activity. For example, if your account was delinquent in December 2016, but you caught up with your payments in March 2017, only to fall behind again in May 2017 and then have the account sent to collections, the negative mark could remain on your credit report for seven years plus 180 days from May 2017.
Avoiding a loan default
The best way to avoid any of the above scenarios is to never put yourself in a position where you will be unable to pay your debts. Here are some tips for pulling that off:
- Never take out a loan or charge something to your credit card that you’re not sure you can pay off quickly. This requires knowing your finances and studying different types of loan and credit products. It may take extra time, but it will save you major headaches later.
- If you have existing debt, always make on-time payments. Consider setting up autopay for monthly bills to prevent missed or late payments. If you can’t repay your debt in full, you should at least make a regular minimum payment on time.
- Check your credit report regularly. Be alert to any sudden score drop. You can get your free reports from AnnualCreditReport.com, the official site authorized by federal law. You can also use LendingTree’s free credit monitoring service. To enroll, visit My.LendingTree.com.
- If you are behind on your payments and your account is severely delinquent, contact your creditor and see if you can negotiate a different repayment plan or settle your debt. You can also look into credit counseling that can help consolidate payments of unsecured debts. To pick a nonprofit credit counseling agency for quality services, visit the National Foundation for Credit Counseling.
Making regular loan payments may seem like a hassle, but they are nothing compared to the pain of collection agencies coming after you or a rock-bottom credit score. On the other hand, staying current on your loan payments can help build your credit score and increase your financial opportunities down the road. Just remember to never take out more than you can pay back, and always try to work with your lender to navigate any trouble you may encounter. And if you do fall behind on payments, and your score takes a hit, seek out ways or consider companies that can help you repair your credit.