The Loans Canada team sits down with Gary Schwartz of the Canadian Lenders Association to talk about open banking.
Loan Default: What You Need to Know
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Depending on the expense that you’re trying to finance, whether it’s for your car, your house, or another kind of personal property, some personal loans can take tens, maybe hundreds of thousands of dollars and months, if not years to pay off in full. Unfortunately, this is something that many would-be borrowers don’t take into account when they’re eager to finance something that’s important to them. When you’ve got that big expense in your sights and are making a decent enough income, it can be tempting to throw caution to the wind and start applying for loans.
However, another thing that many people don’t think through properly are the consequences that will befall them if they aren’t able to make their payments on the regular. In fact, there are a number of ways that your finances and your life will be affected should you end up with an unpayable debt on your hands. Depending on the size of the loan, whether it be unsecured or secured, defaulting on your loan could result in more than a slap on the wrist.
What Does “Defaulting” Mean?
Let’s say, for the sake of argument, that you’ve just gotten a loan for one of the biggest, most important expenses you can take on in your lifetime, a mortgage. For the first few months, everything’s going well. You and your lender have agreed on what seemed like a reasonable payment plan at the time. You’re in stable employment, so your financial worries are minimal. But, what happens if you’re suddenly out of a job or some unexpected event pops up and causes serious harm to your finances. Suddenly, it seems that you will not be able to afford your payments.
Being in default means that you have not been keeping up with the terms of your loan contract. For some lenders, missing one payment means you’re are officially in default, for others you may need to miss a few payments before they consider your loan to be in default. A loan may also be considered in default if your payment is late or if you’re unable to make your payments in full. Whatever the situation right be, you’re in full default and your finances and personal life are suffering because of it. What happens next?
Usually, a lender, either a bank or other company is going to give you a 30-day grace period between each loan payment. When you start defaulting on your payment, that lender is going to call and/or e-mail you with a friendly reminder that you’ve gone over the designated time limit for your payment. Sometimes it can take a day or two, sometimes weeks, but sooner or later they will reach out to you. No big deal, right? Just a polite “sir or madam” and a nudge to get things moving or you could be charged a penalty fee.
More time passes but you’re still too nervous or you forget to get back to them. More reminders will come, voice messages will be left, and letters will arrive in the mail. If you still continue to ignore them and your bills, things are going to get more drastic.
How Does Defaulting on a Loan Affect Your Credit Score
Your credit is a valuable tool that you can use in the future for any number of financial situations. For that reason, it’s important to keep it in good shape. While a lot of lenders won’t even take your score into consideration before deciding whether or not to approve you for a loan, a favorable score can be beneficial in other ways. A high credit score can help you get better interest rates for credit cards and future loans, more reasonable prices for car insurance and other such benefits.
However, once you start defaulting on your loan payments, your credit score is going to be negatively affected. It might take months or it could happen soon after you miss your first payment. Your lender more than likely reports to at least one of the two Canadian credit reporting agencies (Equifax and TransUnion). This means once you stop making payments and default on your loan, the credit reporting agency will know. This is when your credit score will be affected.
While you’re trying to deal with a loan that’s in default it’s likely that you won’t be giving your credit score a second thought. But it’s important to keep in mind that a lower credit score and other financial missteps now, will have a great effect on your financial future and could prevent you from achieving your long term goals.
If you already have a solid credit score prior to your defaulted loan payments, then you will have a greater chance of acquiring an “unsecured” personal loan. This is a type of loan that does not involve any collateral and can be provided to consumers who have high credit scores and good histories of financial stability (keep in mind that there are lenders who do not take these factors into consideration). They can be used for any number of financial expenses, such as covering a medical emergency, buying a new car or other motor vehicle, tuition fees, and debt consolidation.
Unfortunately, the prospect of “no collateral involved” is a notion that many borrowers take for granted, as nothing will be seized in the event of non-payment. The first thing that will happen after you default is your lender will start adding penalty fees onto your bills. More time goes by, still no payment. This is where collection agencies come into play. If you’re still not paying your unsecured loan, your lender might put matters into their hands instead and they will be much more persistent about it. If you continue to avoid your payments, you could end up being subject to a lawsuit. The collection agency will take you to court where other, more serious consequences could land you in further financial trouble. The garnishing of wages is a common practice in most Canadian provinces, with the exception of New Brunswick. This means that any money you make from that point on, as well as any money in your bank account, will be taken until the full amount of your debt is paid off.
This type of loan is called “secured” because the lender requires an asset as collateral in order to provide the loan. An asset can mean a house, car, property, or business. Again, we’ll use one of the more common examples, a mortgage. When you borrow money for your house and you fail to meet the requirements of your mortgage contract, for example of stop making your payments, the lender then has a legal right to seize the property from you.
Filing for bankruptcy is the last resort that many borrowers must turn to when their debt becomes completely out of control. In this scenario, not only will your assets still be seized, but you will likely spend years trying to recuperate from the effects it has on both your credit and finances. In fact, bankruptcy can affect your credit for up to 7 years in Canada, which will prevent you from securing any more loans until you manage to pay everything you owe and rebuild your credit.
For more information on bankruptcy in Canada vs. The United States, click here.
How Can I Prevent This?
Going into default on your loan is certainly not a good thing for both your credit and your financial future. It can take years until you can fully recuperate from the effects, so if you think you’re at risk of defaulting, it’s important that you stay on top of the issue and inform your lender before it gets any worse.
Actually, the majority of lenders would rather have their money back than pursue any legal actions, which will be time-consuming and expensive in their own way. So, whatever the potential cause of your default might be, loss of employment, other debts or another type of financial emergency, you and your lender should be able to work out a compromise. Ask them to reduce the number of your monthly payments and increase the length of your payment term. While you will be indebted to them for longer and you’ll end up having to pay more in interest than you had originally hoped, it’s still better than the alternative of losing your property, being subject to a lawsuit, or filing for bankruptcy.
Another thing you can do is get in contact with a professional before things become too problematic to handle on your own. There are credit counsellors and financial advisors that can provide you with the help, support, and advice you need to make sure you don’t default on a loan.
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