Just like with other credit products, defaulting on a personal loan can have serious consequences. These include a drop in your credit score, limited ability to access credit in the future and facing legal action. That said, there are several actions you can take to avoid default and even get out of it if you’re already down that path.

What is defaulting on a loan?

Defaulting on a personal loan means you’ve failed to make the required payment by the established due date. But missing a payment by a few days won’t immediately affect your credit. In most cases, you’ll only have to pay a late fee. This fee varies by lender, but usually ranges from $15 to $25 or 5 percent of the amount due. If you’re more than 30 days late, however, lenders may report this to credit bureaus — in which case, you’ll see your credit score drop by.

If you’re more than 90 days late, the lender could get your debt charged off, meaning that it has written it as a loss and sell the account to a collection agency. If that happens, you could face legal action and get some of your property seized in order to repay your debt. Not only that, but your credit score could suffer greatly for years to come, limiting your eligibility for future credit products (loans, credit cards, etc.) or your ability to secure one with competitive terms or interest rates.

What happens after you default on a loan?

The consequences of defaulting on a personal loan vary depending on how long you’ve missed your payments. That said, these are the most common scenarios borrowers can face after defaulting on a loan.

  • Damage to your credit: Defaulting on a loan can result in negative marks on your credit report and score. This, in turn, will drag down your score for up to seven years.
  • Limited access to credit: Some lenders may decline future credit applications, as you will be seen as a borrower with a higher risk of default.
  • Higher interest rates: A significant drop in your credit score means that you won’t be able to secure the best terms and interest rates when you apply for other credit products, making your debt more expensive.
  • Legal action: Depending on the type of loan and your state’s laws, what happens when you default on a loan could include debt collection, asset seizure, wage garnishment and a lawsuit.

How to avoid defaulting on a personal loan

Even if you’ve been paying all your bills like clockwork, there are certain circumstances that are out of your control and that could put you at risk of defaulting on your loan. But taking these steps could save you from defaulting on your loan, even in the worst of cases.

Make sure your loan terms work for you

Before you sign for a personal loan, be sure that you are comfortable with your monthly bill, even if you were to experience a reduction of income. A loan that’s too short can result in a higher monthly payment, which may be an issue if you find yourself in a tight financial spot. But getting a loan term that’s too long can cause you to pay excess interest.

Only borrow what you can afford

Budget and crunch the numbers ahead of taking out your loan, as this will give you an idea of how much you need. Although you may qualify for a higher amount, only take what you need and can afford to avoid future financial woes.

Set up automatic payments

If you’re not the best at keeping track of your due dates, consider enrolling in automatic payments, as this will ensure that your payments always get through on time. Additionally, some lenders give an interest rate discount for enrolling in autopay, making your loan less expensive.

Contact your lender

Lastly, if you feel like you may have trouble making payments, contact your lender. In most cases, lenders are able to provide some sort of temporary solution to help you out until your situation improves.

Some of the options that may be available include deferment or forbearance, a modification of your loan terms or emergency assistance.

How to get out of a loan default

If you’ve already defaulted on your loan, try exploring these alternatives to help you get back on your feet.

  • Talk to the lender: This is especially a great option if this is the first time you’ve defaulted on your loan. When doing this, explain your situation and ask if there’s a payment plan available for you to bring your account back to current status. Although this may seem nerve wracking, lenders are almost always willing to help borrowers out, as it is also in their best interest to recoup their investment (the amount you borrowed, plus interest).
  • Consolidation: If your credit is otherwise solid, or you can get a co-signer, you may be able to pay off the default loan by combining it with other open accounts using a debt consolidation loan. However, this solution is best suited for those who mainly have unsecured debt, such as credit card, medical or personal loan debt.
  • Tap into equity: You may be able to borrow against your home or retirement plan to get current on your loan. However, doing this could also come with consequences — such as facing foreclosure if you aren’t able to pay your HELOC or cutting yourself short from retirement savings.
  • Work with a debt relief company: If you’ve fallen behind on multiple accounts and have $10,000 or more in unsecured debt, then seeking third-party help could be just what you need. Debt relief companies negotiate with creditors to get your debt settled for less than what you owe in exchange for a fee. This fee is usually between 15 and 25 percent of the amount settled, which can be pricey, but you’ll typically get back on your feet in less than four years.
  • Seek a credit counselor: A credit counselor may be able to help you outline a plan for paying off the amount due and avoiding similar issues in the future through budgeting and better managing debts. Some organizations, such as the National Foundation for Credit Counseling, may even offer these services for free.

The bottom line

Defaulting on a loan — personal or otherwise — can come with some serious consequences that could harm your finances for years to come. Before applying for a loan or any type of debt, make sure you can afford your payments comfortably, to avoid future financial headaches.

If you’re close to defaulting or have defaulted on a loan, especially due to an unforeseen circumstance, such as a job loss, know you have options. It’s all about exploring each one to find the one that best suits your current situation.