What Happens If I Default on a Loan or Credit Card Debt?
Reading time: 5 minutes
Despite your best efforts, there may come a day when defaulting—ceasing all payments—on one or more of your loans or credit card debts will become unavoidable. Even if you’ve prioritized your debts appropriately and exhausted all alternatives, a default may still occur in a worst-case scenario.
It goes without saying that defaulting on any debt is never good; however, if a default is your only option to avoid eviction or another equally serious outcome, there are things you should know and steps you can take to minimize the damage to your credit scores and other aspects of your finances.
What to expect after a loan default
The impact of a default on your credit history, and by extension your credit scores, can be both catastrophic and long-lasting. A default will stay on your credit reports for up to seven years, and prospective lenders will be far more reluctant to extend credit to you.
You should make an effort to repay the defaulted loan or credit card debt whenever possible. However, if you’re having extended financial difficulties — for example, you or a partner becomes unemployed and has trouble finding a new job, or a family member faces an unexpected medical hurdle — you may find yourself going months without touching the defaulted loan. In the immediate aftermath, you’ll likely receive a stream of communications from the lender as the account goes 30, 60 and 90 days past due. Then one day, the calls and letters may stop altogether. At that point, it can be tempting to think your lender has forgiven the debt, but don’t be fooled. In reality, the lender has probably sold the debt to a collection agency that will soon come after you for the money.
Legal ramifications of a default
In certain extreme cases, on top of damaging your credit reports, a default may land you in court. If you’ve had a loan in default for months or years without paying, your creditor may attempt to settle the debt by pursuing legal action against you. Even if you owe as little as $100, a lender or collection agency can take you to small claims court, provided the statute of limitations—the time period in which a creditor is allowed to sue over a debt—has not run out. In most cases, the statute of limitations is three to six years, though it may be longer for some types of debt.
After the statute of limitations has passed, collectors can no longer take you to court over the debt; however, they can still try to collect by contacting you directly. Note that it’s possible to restart the statute of limitations by making a payment on the debt, making a charge on the indebted account or even entering a payment plan with a lender.
If a collector pursues you after the statute of limitations has passed, you are not without recourse. Ask for the name and address of their company and send a certified letter stating that they should no longer contact you. Once the collection agency has received that letter, further communications may be illegal. If you have not made any payments during a period longer than the statute of limitations and you are still being pursued, you can also speak to an attorney who specializes in fair debt collection practices.
Additionally, a collection agency may sell your debt to another entity that will, in turn, try to pursue you. In fact, it’s possible that a collection agent could come after you 20 or more years later to collect what is sometimes called “zombie” debt.
If a new collector begins pursuing you for a debt that has passed the statute of limitations, be sure to order a copy of your credit reports — all consumers are entitled to a free report from each of the three nationwide credit bureaus each year — and make sure the debt has not been added back to your credit history.
Can a default result in an arrest?
A common practice by unscrupulous debt collectors is to threaten arrest. The good news is this is usually an empty threat, and you generally can’t be imprisoned for not paying a “civil debt” such as a credit card balance, loan or hospital bill. However, failing to appear for a designated court date related to a debt may result in a warrant for your arrest. Additionally, you may face jail time if you fail to pay your taxes or child support.
Under the Fair Debt Collection Practices Act (FDCPA), debt collectors cannot claim they have the power to arrest you unless the threat is true. If you know that you’re not at risk of arrest but are receiving these calls anyway, the Consumer Financial Protection Bureau encourages you to send a letter to the collection agency telling them to cease and desist. Be sure to make it clear that you know your rights and understand the actions they can and cannot take against you.
Recovering from a default
Recovering from a default and reversing the damage caused to your credit scores are neither quick nor easy, but they can be done. You should start by paying off any outstanding debts that are impacting your credit score. If you still have a significant amount of credit card debt, you may want to try consolidating it with a balance transfer. This can lower your overall interest rate and make it simpler to pay down your debt. Once you begin paying off balances, your debt-to-credit ratio will improve, which can help your credit scores.
Next, be sure to make all monthly payments on time and in full, if possible. Timely payments will have an overwhelmingly positive effect on your credit scores. If you’re struggling to make payments on time, try setting up automatic payments or reach out to your lender to negotiate a payment plan that will work for you both.
Default is never an option to be taken lightly. So if you’re in a situation where a default is unavoidable, it’s important to understand the consequences. Be sure you know your rights and do whatever you can to minimize the fallout by paying your debts as soon as you’re able.