What happens if I default on a personal loan?

Not only is defaulting on a personal loan expensive, it can also do some serious damage to your credit score. However, being informed can help you get back on the path to financial wellness. We break down what defaulting on your loan means, its consequences and what to do if you’re about to miss a payment or already have.

When is a personal loan considered in default?

It depends on your loan type, the lender and the terms of your agreement. Many personal loan contracts consider your loan to be in default 30 days after you miss a repayment. Some contracts give borrowers 60 or 90 days before it’s considered in default.

Often, a lender won’t report a repayment as late to a credit bureau until around 30 days after the due date. This means that most of the time, any repayment under 30 days late won’t hurt your credit score. To know your loan’s specific terms for default, check your loan contract or contact your lender.

The longer you wait to make your repayment, the worse it is for both your finances and your credit score.

5 consequences of defaulting on a personal loan

A personal loan default can affect your life in several different ways. Many people start getting lots of phone calls from debt collectors after they default and some even face legal action from their lender. Here are five things that might happen if you don’t make that repayment within 30 days of its due date.

1. Additional fees

Most lenders charge late fees — for each repayment you miss, you’ll have to pay a late fee. Each time your lender unsuccessfully attempts to withdraw from your bank account, you’ll have to pay a non-sufficient funds fee (NSF).

As we mentioned earlier, some lenders offer a grace period before these fees kick in. However after that’s over, you’ll be charged a late payment fee either expressed as a percentage, a flat fee or an additional interest payment. Non-sufficient funds fees are almost always a fixed, one-time fee. Like late fees, these typically range from $15 to $50 and are often the same amount as the late fee if it’s fixed.

If you think you’re going to miss a repayment, you might want to stop automatic repayments. That way, your lender won’t try to unsuccessfully access your bank account and you’ll only pay a late fee (instead of both a late fee and a non-sufficient funds fee).

2. Lower credit score

Your repayment history is an important factor in your credit score. Even missing one repayment can significantly lower your score and go on your credit report for up to six years, while defaults typically stay on your credit report for seven years.

3. Harder to qualify for future credit

Having a default on your credit report tells a lender that you haven’t always honoured your contracts and might not be a responsible lender. Many reputable lenders won’t work with anyone who has defaulted recently. Even if a lender will, having a bad mark on your credit report can make it difficult for you to qualify for competitive rates on personal loans, credit cards, mortgages, car loans and any other type of financing. In turn, you’ll pay excruciatingly high interest rates that might not be affordable and ultimately throw you into a spiral of ongoing debt.

4. Lose your collateral

Thought you’d save on interest by taking out a secured loan? That collateral is no longer yours once you default on your loan. If you used your car or another possession as collateral, your lender will send someone to collect it. If you backed your loan with a bank account, then it’ll collect whatever funds you have in it up to the amount that you owe.

5. Garnished wages

After your lender sends your loan to collections, it might file a lawsuit and obtain a judgement from court to garnish your wages. If it’s successful, it’ll take funds directly from your paycheques and tax refunds until you’ve paid off your loan plus any interest. Wages can be garnished in all provinces and territories across Canada, except for New Brunswick.

How much your lender can take from your wages depends on the province or territory you reside in. Low limits typically sit around 30% of your wage, while higher limits tend to sit around 50%. In British Columbia for example, lenders can garnish 30% of your monthly salary, while in Alberta, you get to keep the first $800 you make and lenders can garnish 50% of your income when you make $800 to $2400. Any income received above $2400 in Alberta can be 100% garnished.

It’s important to note there are many rules surrounding garnished wages. For example, if you’re self-employed, owe child support or owe the CRA money, any provincial or territorial limits on the amount of your wage that can be garnished likely won’t apply to you. Garnishing wages is also extremely common in Canada, so it’s something you’ll want to be aware of if you think you’re going to have trouble repaying your loan.

Finder survey: Are men or women more likely to rate monthly repayments as an important factor when applying for a personal loan?

Worried you might default on your personal loan? Here’s how to avoid it

Fortunately, there are steps you can take to prevent your loan from going into default. If you think you’re going to miss your next repayment, you might want to do some or all of the following:

• Contact your lender. Calling or visiting your lender in person might be the fastest way to alert your lender that you might have trouble making a repayment. Many lenders are willing to work with borrowers by adjusting your loan term to lower your repayments or taking other steps to make sure you don’t miss a repayment.
• Ask your family and friends. In times like these, your social safety net might come in handy. Explain the situation to a relative you trust and ask if they can help you out. You can even set up a formal contract through online programs like Loanable.
• Talk to your employer. Some companies might be willing to give you a pay advance if you’re in a tight spot with a lender. Ask your human resources department what your employer’s policy is for paycheque advances.
• Talk to a credit counsellor. Struggling with your personal finances in general? Going to a credit counselling agency may help you get back on track and strategize about how to avoid missing a repayment.

Already in default? Here’s what to do next

The sooner you can get out of default, the faster you’ll be able to start building your credit. While that negative mark will stay on your credit report for six or seven years, you can start taking steps to regain your financial health right away.

• Pay your late payment and fees. Just missed the cutoff for late payments? Try to pay off that late payment and fee before it goes to collections. If you let it sit too long, your lender could sue you for repayment or file a lawsuit to garnish your wages.
• Negotiate a settlement. Already in collections? You might be able to negotiate your debt down to a large one-time payment. You can do this on your own through a process called debt consolidation or you can hire a debt settlement company to do it for you — though you’ll want to make sure you’re working with a reputable organization.
• Get credit counselling. Credit counselling can also help after you’ve already defaulted on your loan by helping you come up with a debt management plan for paying off your loan and staying out of debt.

Bottom line

Defaulting on your personal loan can have serious consequences that follow you around for a long time. Whether you’re about to default on your loan or already have, it’s crucial to take action as soon as possible. Aside from the fees and the potential legal consequences, the longer you let your loan sit unpaid, the more you’ll owe in interest.

Frequently asked questions

• Do I have to repay a loan if I file for bankruptcy?

  It usually depends on the type of loan. If you have a secured loan and you plan to keep the asset that you have used as collateral, you will need to pay the loan back. If your loan is unsecured or you’re willing to lose the asset for your secured loan, after your bankruptcy is discharged, you will usually not have to pay back the loan.

• How do I find a legit credit counselling agency?

  There are a list of reputable websites and associations here that can connect you with a trustworthy credit counselling agency near you.

• I make money off of tips. Can my lender garnish my wages?

  Yes, typically most forms of income, including tips, can be garnished by a lender.