How Defaulting Affects Credit Report

How Does Default Impact Your Credit?

Quick Answer

Defaulting on a loan or credit card places a negative mark on your credit reports that can hurt your credit scores for seven years—but it also can signal future events that do even greater damage to your credit.

How a Default Affects Your Credit

Lenders use credit scoring systems to forecast defaults so they can avoid them, or at least anticipate and manage them. Because a loan default indicates you've fallen behind on loan payments—or stopped making payments altogether—a default on your credit reports has a significant negative impact on your credit scores. A default entry will remain on your credit reports for seven years, with negative consequences for your credit.

The number of points a default will lower your scores is highly variable, partly because anytime you default, your scores are already falling. You'll have racked up at least two major score-damaging events: payment entries marked 30 days late and 60 days late. How many credit score points those events cost will depend on factors including what your score was when you missed the first payment, how many negative events appeared on your credit reports previously and how recent they were.

Before you default on a debt, the lender will make multiple efforts to reach you about your missed payments. It's much better to communicate with your lender before you default than after, but it still may be helpful after a default to speak with the lender (or the collection agency, if your account has been sold to one) to resolve the matter.

You'll likely have to make at least partial payments against the debts, and any settlement for less than what you owe will be noted in your credit reports, where it will remain for seven years. If you cannot make the payments needed to satisfy these creditors, your only option may be filing bankruptcy (and even that can't shield you if you've defaulted on a federal student loan).

While a credit score drop might not be unexpected after a credit default, how lenders respond to defaults vary and can be serious. The nature and speed of those responses depend on applicable laws, the amount of the loan and the loan type—but all have extreme negative consequences for your credit.

Mortgage Loan

Defaulting on a mortgage usually triggers foreclosure: seizure of the property to satisfy your obligation to the lender. The lender typically notifies you of their intention to foreclose within 30 days of the loan becoming 120 days delinquent.

In the meantime, the lender may publish its intention to foreclose in local news outlets and submit paperwork to the court documenting its right to foreclose. This is your last opportunity to halt foreclosure. If you wish to do so, it's highly advisable to hire an attorney to try to persuade the lender (or the court) to accept an alternative to foreclosure. A foreclosure stays on your credit reports for seven years and is a major red flag to lenders.

Auto Loan or Other Secured Credit

Defaulting on a car loan, or any other loan secured by property that isn't real estate (such as a boat, RV, cellphone, furniture and the like) typically triggers the repossession process. The lender has the right to seize the collateral to settle your obligation and may assign additional outstanding debt to a collections agency.

Repossessions and collection accounts stay on your credit reports for seven years, and adversely affect your credit scores as long as they remain.

Student Loan

Defaulting on a student loan brings trouble. If it's a federal loan, unless you pursue a loan rehabilitation procedure that gets payments back on track, your wages, tax returns and federal benefits (such as Social Security) can be seized to settle the debt.

Private student lenders typically turn your account over to a collection agency, which may add fees to your debt, pursue repayment relentlessly and sue to compel repayment. A collection account remains on your credit reports for seven years, with negative results for your credit scores.

Credit Card or Personal Loan

If you default on a credit card account or personal loan (both forms of unsecured credit), the lender can turn your account over to an in-house collection department or sell it to a collection agency. These entities will aggressively pursue repayment and may seek a court order that garnishes your wages or places a lien on your house. The collection entry will appear on your credit reports for seven years, hurting your credit scores.

How to Improve Your Credit

The harm to your credit from a default, and from the additional actions lenders may take in response to it, can be deep and long-lasting. But in time, you can improve your credit by adopting good debt management habits such as:

Pay all your debts on time, without fail. On-time payments benefit your credit scores and, as we've seen, late and missed payments hurt your scores.
Consider credit-building tools. A default and its aftermath can make it difficult to qualify for traditional loans and credit cards, but secured credit cards and credit-builder loans, products designed to enable payment patterns that benefit credit scores, can help you begin rebuilding damaged credit.
Keep credit card balances low. Carrying balances in excess of about 30% of your cards' borrowing limits can seriously hurt your credit scores. Paying down high balances, and especially paying off your card balances every month, can benefit your scores.
Seek only credit you need, as you need it. Credit checks associated with applications for new credit typically cause small, temporary dips in your credit scores, and multiple applications over a short time can have a cumulative negative effect on your scores.

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.

The Bottom Line

Defaulting on a debt has major credit repercussions, and the aftermath of a default can do even more harm to your credit history and scores. Communicating with your lender(s) before you allow 90 days to pass without a payment may help to avoid the worst of these consequences.