Become a Financial Modeling & Valuation Analyst (FMVA)®. Enroll today to advance your career!
Login to your new FMVA dashboard today!

Debt Default

The failure to repay a debt when it is due

What is a Debt Default?

A debt default happens when a borrower fails to pay his or her loan at the time it is due. The time a default happens varies, depending on the terms agreed upon by the creditor and the borrower. Some loans default after missing one payment, while others default only after three or more payments are missed. In such an event, serious repercussions can happen, such as getting a poor credit rating.

 

Debt Default

 

Debt default notice

Before a debt becomes in default, a notice of debt default is sent by the creditor to the borrower, stating how far behind the debtor is in his or her payments, as well as how much is needed to keep the payments updated. Usually, the notice gives the debtor about two weeks to cover the missed payments. Otherwise, the debt will default.

 

Debt default on secured loans and unsecured loans

A debt default on a secured loan means repossession of the collateral. For example, a person who defaults on a car loan will need to surrender the car to the creditor, just as somebody who defaults on a home equity loan must face foreclosure of the house.

However, for defaults on unsecured loans without collateral, such as credit card purchases, the borrower is typically given a grace period of, for example, 30 to 60 days. During this period, the borrower needs to make the required payments or risk having his account referred to the company’s collections department, which will then change the account’s status to default.

When this happens, the ccreditor may sell the default account to a third-party collector who will take over the collecting of the fees, and who may even charge higher fees to get their cut from the debt. If at this stage, still no payment is made, the third party may bring the matter to a lawyer’s office. The attorney may take the borrower to court if the debt is still not settled.

 

What happens in a debt default

A debt default comes with consequences that can have lasting effects on the borrower’s reputation and credit score. Credit represents an individual’s ability to borrow money. When an individual applies for a loan, whether secured or unsecured, the creditor looks at the person’s credit score because it helps determine if the person is likely to be able to pay back the loan and its interest.

 

Here are other things that happen in a debt default:

 

#1 Annoying collectors

This is one of the most disturbing things that occur in a debt default. After receiving the debt default notice and still failing to make payments, a third-party collector will bombard the borrower with calls to get the payments. They can even come to the point of going to the borrower’s workplace, which often causes embarrassment.

 

#2 Legal problems

If a debt defaults and no settlement is reached despite negotiations, the collections department may secure a lawyer’s services that will send the final written notice of collection to the borrower. After all other means of collecting the debt have been exhausted, the law office may pursue a case against the borrower.

 

#3 More fees to pay

The irony of a debt default is that when a borrower fails to pay his dues because of financial difficulty, that actually leads to incurring more fees that need to be paid.

 

what happens in a debt default

 

How to avoid a debt default

Debt defaults can often be avoided if the borrower takes the issue seriously and handles o.

 

#1 Acceptance

The first step to avoiding a debt default is acceptance. What needs to be accepted is the fact that debt was incurred because of the lack of sufficient funds. Now, if a debtor defaults, how would he be able to pay the loan, plus all the penalties and fees?

 

#2 Follow a budget

Working and living on a budget should not be seen as depriving oneself of the pleasures of life, but merely as living within one’s means. A budget must be prepared each month, setting aside a specific amount of money for each category of expenses, such as groceries, utility bills, insurance, and others. Sticking to the budget is the key.

 

#3 Track debts

Tracking debts is especially useful for people who have more than one debt. It can help to create a single form that details every type of debt, the individual due dates, and the amount due for each. Place the debt tracking list in a strategic and secure location.

 

#4 Ask for help from the family

Debts have to be dealt with by the entire family, not just by one member. Though involving the kids and letting them know of these debts is discouraged, the husband and wife should help each other in keeping track of debts.

Communication is not only for the husband and the wife but also between the couple and the creditor. If there is a likely chance that a payment will be missed, it will help to contact the creditor as soon as you are aware of a possible problem. Explain your situation and ask for a little leeway, with a promise to bring the payments current as soon as possible.

 

More resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Accounts Payable
  • Peer-to-Peer Lending
  • Revolver Debt
  • Trade Credit

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career path.

 

Learn financial modeling and valuation in Excel the easy way, with step-by-step training.