How to Avoid Defaulting on a Debt Consolidation Loan

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Claire Matthews

Financial Advisor, DCL

How to Avoid Defaulting on a Debt Consolidation LoanIf your debt is overwhelming and you are searching for options to reduce or eliminate your debt, then you may be considering a debt consolidation or other type of loan to help get your finances back on track. To avoid defaulting on debt consolidation loans, you need to plan ahead of time, before you sign any type of loan agreement.

The Consequences of Defaulting on a Debt Consolidation Loan

The consequences of defaulting on a debt consolidation loan depend on the type of loan you have and the details of the loan agreement. Of course, defaulting on any loan is going to damage your credit score, and you will be facing various collection procedures depending on how long you remain in default. The consequences may vary depending on if your loan is secured or unsecured.

Secured Loans

A mortgage or car loan is secured debt, because the house or the car is the collateral – if you fail to pay, your house or car can be taken as payment for the debt. Not a fun situation to be in. An auto title loan and a home equity loan are both considered secured loans.

A home equity loan is also known as a second mortgage. In return for putting your house up as collateral, you will receive a lump-sum payment or a line of credit, which you will repay in monthly installments, along with a loan fee and interest charges. If you default on a home equity loan, the lender can foreclose on your house after around 120 days after you first default.

An auto title loan is based on the same concept as a home equity loan. Depending on your credit score, you may be charged an extremely high interest rate on this type of loan, which can increase your chances for defaulting on your payments.

Unsecured Loans

Unsecured debt is any debt or obligation that is not protected or secured by property or collateral. Basically, unsecured debt is any debt that is not secured with an asset, such as student loans, medical bills, and credit cards.  If you default on unsecured debts, there is no property for the lender to recover, so they will go to great lengths to receive some type of payment from you.

Most unsecured loans offer a grace period to make the monthly payment, but others may not, so you should know the details of your loan agreement. If you default on an unsecured loan, you will be charged late fees and an increased interest rate on the remaining loan balance. After 90 days of non-payment, your account will be considered in default and your account will be turned over to a collections department or agency.

Between 120 and 180 days, if you have not contacted the lender to negotiate a repayment plan, your account, you will be faced with continuing phone calls from collections agencies attempting to reclaim the loan.

Before your default reaches this stage, you should contact the lender and make every effort to negotiate a repayment you can afford that will keep your loan from going to collections. Once your loan has been passed on to a lawyer, it may be too late for negotiations.

If you are taken to court due to non-payment of an unsecure loan, the court can issue a judgment against you, which will require you to pay the loan amount in addition to attorney fees and court costs. This court proceeding will also be a matter of public record, so it can affect your ability to rent an apartment or get a car loan in the future. If you cannot pay your debt, the court may order garnishment of your wages, in which they can take 25% from each paycheck to receive their money.

Going through a court proceeding for defaulting on a loan will severely damage your credit score and credit history. If you negotiate with the lender before your default reaches this status, you may save yourself points on your credit score and the stress of going to court and having your wages garnished.

How to Avoid Defaulting on a Debt Consolidation Loan

Understand the Loan Details Before You Sign

The most important factor to avoid defaulting on a loan is to know the details of the agreement before you sign for the debt consolidation loan, regardless of if you choose a standard debt consolidation loan, a home equity loan, or any other type of loan. You should understand the loan fees, interest rates, payment requirements, and the monthly payment amount.

If you are not sure you can afford the monthly loan payments, do not take out the loan! You must be sure you can afford the monthly installments to avoid defaulting on the loan. Be aware of the loan term as well, so you know how long you will be required to make the payments.

Develop a Budget

If you are using a debt consolidation loan to eliminate or reduce your debt, simply getting the loan will not have the effect you want if you continue to use credit cards or lines of credit with high interest rates. You will need to stop using all credit cards and make lifestyle changes so you can live with only your income and no other assistance.

Analyzing your debts and your expenses can help you develop a plan to succeed in overcoming your debts. Go through your expenses and see where you can make some cuts. Even if you already have a debt consolidation loan, it is never too late to start saving money. If you can build up a savings, this can help you avoid defaulting on a loan if you have unexpected expenses that pop up making it difficult to stay current.

Increase Your Income

You may want to consider picking up a part-time job to make some extra money. The more money you can save, the less likely you are to default on your debt consolidation loan. There are many opportunities for increasing your income, but you should find something you enjoy. It is easier to stick with the plan if you enjoy what you are doing. Perhaps you can do some babysitting or lawn care, or maybe you want to check for online opportunities you can do from the comfort of your own home.

If you can cut back on your expenses and increase your income, you are on a great path to staying current on your loan payments, even during months where you are stretched a little thinner than usual. Once you have built up a good amount in your savings, you may even be able to make more than the minimum monthly loan payments, so you can pay off the loan faster. The faster you repay the loan, the more you are saving in interest rates.

Get Help from a Credit Counselor

Before you decide to pursue a debt consolidation loan, it is a good idea to seek the help of a credit counselor. There are many non-profit organizations who offer free credit services, although they may charge a minimal fee for some services. A credit counselor is a professional who is educated and trained in finances and debt solutions.

When you visit with a credit counselor, they will help you lay out all your debts and expenses and compare that to your income. Based on your specific financial situation, they will provide recommendations for the best debt reduction or elimination plan for you. Options other than debt consolidation may include debt settlement or debt management plans that do not involve getting a loan.

Doing a little research and putting in some effort can go a long way in preventing a default on a debt consolidation loan. You should know exactly what you are signing up for, and have a predetermined plan for success.

What Do I Do if I’ve Already Defaulted on My Loan?

You need to act now. Contact the lender to see what they can offer in terms of allowing you to catch up on your payments to get your loan out of default status. If you have not already done so, you will need to make immediate sacrifices so you can put more money toward your loan and less toward additional expenses that may be necessities. The more you can offer the lender, the more likely they will be willing to negotiate.

Keep making payments for as much as you can even if your loan is in default.  If the lender is receiving some money from you, they may be willing to work with you and prevent your loan from officially falling in to default status.

Get a second job right now. It’s not as difficult as it may seem, and there are endless opportunities for part-time or online work that can put more money in your pocket. You may also want to contact a non-profit credit counseling agency, as they can help you determine the best path to overcoming defaulting on a debt consolidation loan.

Bankruptcy

Bankruptcy may be an option to consider if you are overwhelmed by your debt or have defaulted on your debt consolidation loan. Bankruptcy is a last resort for people who have significant debt and other financial issues.  It is a legal proceeding that can have a lasting effect on your credit score and any property or assets you may have.

Although all your unsecured debt will be wiped out, such as credit cards and medical bills, you may lose your house and your car, and it may be difficult to rent an apartment or buy a new car after it is discharged. A bankruptcy leaves a stain on your credit that will last anywhere between 7 and 10 years.  It is a relief for some people, though, because creditors and collections agencies are not permitted to contact you once you file. Bankruptcy also allows the person to get a “fresh start” with most of their finances.

Keep in mind, if you file for bankruptcy, you cannot include federal student loans, and you will also have to pay a lawyer to file the bankruptcy on your behalf. You will have to go to a court and answer questions about your finances and assets, and you will have to have proof for all claims. Because bankruptcy is a court procedure, it is also a matter of public record, so keep that in mind as well. There is no hiding a bankruptcy from anyone.

If you have defaulted on your debt consolidation loan and it has been passed to a collections agency, you will want to begin the bankruptcy proceeding before it is turned over to a collections lawyer. You want to avoid going to court for defaulting on a loan at all costs.

It is Up to You to be Responsible

Defaulting on a debt consolidation loan is not a good thing. Not only will it damage your credit, but it will cause you to pay back more money due to late fees and increased interest rates. Being proactive is always best. If you know you can’t make a payment on time, contact the lender to inform them of your situation. Many lenders will work with you or allow you to make a late payment without charging a late fee or raising the interest rate.

If at all possible, you will want to avoid your loan account going to a collections agency, because this will only lead to more phone calls and it will eventually lead to a collections lawyer taking action against you.

It is up to you to borrow responsibly, and do some research to make sure you are using a reputable lender and getting the best deal possible on your loan. You should have a plan for making the monthly payments, as well as making cuts to your expenses to build up an emergency or savings fund. Develop a budget with the help of a credit counselor, and stick to it.

 

Claire Matthews

Claire Matthews

Financial Advisor, DCL

Claire is a noted financial writer and author of hundreds of articles about personal and business finance. Before getting her MBA, she graduated with a BS in Economics. Her coursework focused on the different ways that debt, debt structure, and debt restructuring affect micro and macro-economic issues.

Upon graduation, she took a job at an investment bank that worked with municipal and county governments to help them reorganize and structure their debt so they could continue to provide essential city services.

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