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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 vary, depending on the terms agreed upon by the creditor and the borrower. Some already default after missing one payment while some 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 of 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 up 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 offered such as credit card purchases, the borrower is given a grace period of usually 30 to 60 days. During this period, the borrower needs to make the required payments or risk to his account getting referred to the company’s collections department, who will then change the account’s status to default.

When it happens, the company may sell the default account to a third-party collector who will take over the collecting of the fees and 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 this to a lawyer’s office who may take the borrower to court if the debt is still not settled.


What happens in a debt default

As already mentioned, a debt default comes with consequences that result in lasting effects on the person’s name and credit score. Credit is the individual’s ability to borrow money and identifies the amount that can be approved for borrowing. 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 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 when defaulting on a debt. 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 already secure a lawyer’s services that will send the final written notice of collection to the borrower. After all means have already been exhausted, the law office may pursue a case against the borrower.


#3 More fees to pay

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


what happens in a debt default


How to avoid a debt default

Debt defaults can be avoided if the borrower takes the issue seriously.


#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 is not depriving oneself of the pleasures of life but living within one’s means. A budget must be prepared each month, setting aside a specific amount for each category like groceries, bills, insurance, and others. Sticking to this budget is the key.


#3 Track debts

Tracking debts is especially useful for people who have more than one debt. It would help to create a single form that details every type of debt, the individual due dates, and the amount due for each and place it in a strategic 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 these debts.

Communication is not only for the husband and the wife but also between the couple and the creditor. If there is the likely chance that a payment will be missed, it will help to contact the creditor and explain and ask for a little leeway, with a promise to make the payment 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

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