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Why Defaulting on a Loan Will Sink Your Credit Score

When you take out a loan, you don’t expect to default on it. However, despite your intentions to pay the loan off, you may find it difficult to pay off a loan. No matter the reason, be it job loss or personal crisis, making a late payment or defaulting on a loan can add pressure on your struggles. Before getting into a difficult situation, it’s important to understand how defaulting on a loan can affect your credit. 

First Missed Payment 

Missing just one loan payment can lower your credit score. Once your loan payment is 30 days late, you will have to pay the past due amount and any applicable fees to mitigate any potential damage to your credit score. This can further be prevented by making all other payments as expected and on time. 

When you miss a payment and proceed not to pay it and then miss the rest of your payments, the loan will fall into default. 

Late Payments

If your payments on the loan are more than 30 days late, you can trigger serious consequences. These include:

Loan Default

A  defaulted loan may appear on your credit reports, which means it will begin lowering your credit score. Lenders use your credit score to review applications, so it’s important that you don’t default if you’re planning on opening a new account in the near future. 

Phone Calls and Letters

Before a defaulted loan goes into collections, you should expect contact from the lender of the loan. This means that you will receive phone calls and letters from creditors who want payment.

Collections

If you choose to ignore the letters and phone calls and still do not pay your debts, your account will be sent to collections. A debt collector will then seek payment from you. 

Unfortunately, the collection can remain on your credit report and affect your credit score for up to seven years. Your account going into collections can damage your creditworthiness when you need a future loan or credit card. It will also be a deciding factor when you try to obtain a poor credit merchant account for your business. 

Avoiding Loan Default 

When it comes to avoiding default on a loan, you’ll have a few options depending on the type of loan. For example, a student loan will provide you with deferment or forbearance options so that you can temporarily stop making payments or pay less each month. 

A mortgage, on the other hand, may offer you a loan modification. This will change the loan from an adjustable-rate to a fixed rate, or extend the loan life so that you can make smaller monthly payments. 

Rebuilding your Credit 

Defaulting on a loan will negatively impact your credit score for up to seven years. However, the good news is you can begin rebuilding your credit soon after you go into default and improve your standing over time.