Signature Loans: Here’s What Happens If You Default
Life can come with all kinds of costs, from medical bills and student loans and to wedding or vacation expenses. Unfortunately, we don’t always have the cash on hand to cover them and can end up borrowing money.
A signature loan is a common type of loan typically available to those who have good to excellent credit. Unlike with a mortgage or car loan, you don’t put down collateral with a signature loan — all you need to do is sign on the bottom line that you promise to repay what you borrow according to the terms.
But unfortunate circumstances like a job loss or unexpected illness can happen, even to those who have good credit. And just because you didn’t put down collateral doesn’t mean there aren’t any consequences when you fall behind on payments for a signature loan.
Here’s what you need to do if you’re behind on payments, and what happens if you default.
- What to do if you’re falling behind on payments
- What happens when you stop making payments
- Understanding the statute of limitations on debt
- How to get your signature loan out of default
What to do if you’re falling behind on payments
Sometimes, honesty is the best policy, especially when you’re falling behind on payments.
For those who are falling behind and risking default, “the very most important thing they should do first is call their bank,” said Vincent Averaimo, a default services attorney for lenders and non-bank servicers at Milford Law in Milford, Connecticut. As he noted, many lenders and banks are able to evaluate loans and assess possible loss mitigation options for at-risk borrowers.
These loss mitigation options include:
Forbearance: Let’s say that your signature loan payment is $500 per month at a 6.50% interest rate, but now you’ve already missed two payments. Call your lender and they may be able to put your loan on forbearance for a certain number of months. However, as Averaimo noted, it’s important to know that the loan will still continue to accrue interest and the missed payments will eventually become due at the end of the term, as either a balloon payment or an installment loan.
Loan modification: Maybe you can’t afford the $500 per month payment, but you can afford to pay a little less each month — Averaimo suggested several ways in which your loan could be modified. Lowering your interest rate “will ultimately change your monthly payment to hopefully become more affordable for you,” he said.
Adjustments could also be made to your term, which could make your payments even lower if paired with a more favorable interest rate. “Maybe you’re already 10 years into a 20-year note or a 15-[year] note, but now the note gets extended,” said Averaimo. In turn, “[this] reduces the monthly payment to make it more affordable to you, but also reduces the interest rate.”
Payment plan: You’ve already missed two payments, but now you’re back on your feet and ready to continue meeting your obligation. Your lender may break up the two missed payments and add them to your regular payment over, for example, a six-month period, to help you catch up, said Averaimo: “Once you get to that sixth month, you’ll catch up on [what you owe] and then you’ll be completely current.”
Whether or not a bank or lender works with a borrower who is already in default depends on their individual circumstances. However, keep in mind that as soon as you miss a payment, the bank has its own financial responsibilities to recoup your payments, including contacting your co-signer.
“A co-signer would be on the account,” said Adam Taylor, owner/CEO of Taylor Financial in Tampa, Florida, “and they sign a promissory note and it’s only called upon in the event the original lender defaults on his or her payment.”
What happens when you stop making payments
Days 30 to 60: You’ve missed a payment. The lender immediately starts calling you to see if it was just an oversight and when they can expect the payment to be made and may charge you a late fee. As soon your delinquency goes over 30 says, the bank is preparing their necessary paperwork to settle the debt.
After 30 days of delinquency, the lender will alert the credit bureaus and send you an official letter of default. “Generally speaking, 30 days is when you start getting reported,” Averaimo added, “and it starts really damaging your credit.”
According to data from FICO, which provides credit scoring services, a delinquency that goes past the 30-day mark could cause your credit score to drop significantly, even if you’ve never missed a payment before. This drop could be especially high if you have a higher credit score.
Days 60 to 90: The lender will make numerous attempts at contacting you to make payment arrangements and offer suggestions on how the default can be resolved. At 60 days delinquent, the lender will again report that you were late to the credit bureaus and your credit score will continue to drop.
After 90 days: If you have not resolved the debt by the time you are 90 days delinquent, most lenders will begin the litigation process.
As Averaimo noted, at this stage, it is likely that “the bank will again make an overture to the borrower,” but the borrower won’t respond in a timely fashion — if they respond at all. However, once litigation starts, “now there are discussions about settling this debt,” he said, and it becomes “a matter of how much will be owed and over how much period of time [you’re able to] pay this back.”
Understanding the statute of limitations on debt
One important thing to keep in mind when it comes to old debt is the statute of limitations, which is the specific period of time during which a creditor can file a lawsuit to collect a debt. The length of this statute will depend on the laws of your state, as well as the type of debt that you owe (mortgage, auto loan, etc.).
According to Taylor, where he’s located, the statute of limitations depends on the type of debt: “I know for contracts, such as personal loans or signature guarantees, the statute of limitations is five years.”
While you technically still owe the debt after the statute of limitations has passed, the creditor can no longer take legal action to recoup it. However, if you make even a partial payment on the debt, you effectively will reset the clock on the statute of limitations and reopen the possibility of legal action.
You can learn more about the statute of limitations and state-specific details here.
How to get your signature loan out of default
Hopefully at some point you will be back on your feet and ready to resolve your debt. Perhaps by now though you already owe months of back payments, so where can you get the extra funds?
Borrowing against your 401(k) or IRA is one possible option. “I’ve also seen people borrow off of their 401k’s [and] IRA’s,” said Averaimo, “or even their whole life insurance policies to get the amount of money that they need to reinstate their loan.” However, he urged caution with taking this step, acknowledging it could be end up being “pretty detrimental to someone’s overall portfolio.”
You may also consider a debt consolidation loan. With this type of loan, you roll multiple types of debt into one new loan. Ideally, your debt consolidation loan will have more favorable terms, such as a lower interest rate and fewer fees. However, you could opt for a longer repayment term, lowering your monthly payments. If do that, however, you’re liable to pay more in interest over time.
A debt consolidation loan won’t erase your debt — just move it and hopefully make it easier to repay. You’ll still be responsible for repaying the full amount.
If your home has equity, a home equity loan or line of credit could offer a lower interest rate. “Let’s say your house is worth $300,000 and you owe $200,000 on it,” posited Taylor. You’d have $100,000 equity within your home, which could be used to pay off your signature loan.
“The downside there is you’ve transferred from one pocket over to the other,” he noted. “The positive is that you may have a longer time period to pay off the home equity line of credit than you would from a personal loan, and interest rates may be lower.”
Not everybody can see an unfortunate series of events coming. But if you’re falling behind on payments, communicating with your lender could help you find a plan that can save you from default. Doing so could spare your credit score from damaging dings. Once you’re in default, your options for getting out are more limited.