There is a general misconception that finance companies tend to be unhelpful when customers are struggling. However, if you sit back and look at this from a distance, this idea doesn't quite make sense.
Why would a finance company proceed with often expensive court action to reclaim funds from a struggling customer? If the customer had the money, they wouldn't stop their payments. Thankfully, there are numerous ways in which customers can tweak their financial arrangements to alleviate any short-term pressure. However, if your situation is unlikely to improve, it is essential to know the formal process.
Communication from your finance provider
When you miss your first loan payment, your lender will likely send you a courtesy letter/email asking you to rectify the situation as soon as possible. It may be an oversight, short-term financial issues, or even a problem with the transfer from your bank. If you receive such communication from your lender, it is advisable to contact them and discuss your situation. You may find the communication offers an array of different options. Consequently, there may be light at the end of the tunnel without more formal proceedings.
It is important to note that your lender is unlikely to contact the credit rating agencies about one, two, or even three missed payments. Thus, ensuring that only serious issues are reported and considered when calculating your credit score. However, it is not a situation you should let drag on for any length of time.
There is a formal process when customers fail to honor their monthly loan payments. Again, it will depend upon the individual lender, but they may wait up to 6 months before issuing a formal default notice. This notice is a legal acknowledgment that you are behind with your loan payments and the finance company has the option of taking legal action.
A default notice is a severe escalation of the issue. This brings into play an array of different actions that the lender can take to recover funds owed.
Impact on credit rating
As we touched on above, lenders are unlikely to contact credit rating agencies if you missed up to 3 payments. On the issue of a default notice, your credit file will be updated, and your credit score negatively impacted. Unless there has been a genuine error, you will find it near impossible to reverse entries on your credit file.
Default notices and other issues noted on your credit file will not last forever. They are likely to be recognised for several years, but over time the impact on your rating will diminish if there are no further missed payments. Nevertheless, it is essential to be aware of the long-term effect on your credit rating and how it might affect future finance applications, even if your financial well-being improves dramatically.
Many loan companies use collateral to add a degree of security when lending money to customers. Some applications may require collateral due to the applicant’s challenging credit history, while others may choose to use collateral to secure the best deal. So, how long before the lender calls in collateral on a loan default?
Surprisingly, lenders tend to hold back from calling in collateral, especially those which may prove a little challenging to sell. Instead, they prefer to sort out new repayment plans with customers experiencing financial difficulties rather than go through the added expense of calling in some forms of collateral. However, do not be under the illusion that your collateral won't be sold if this is the only option.
Contact loan guarantors
In a similar fashion to collateral, some loan customers will use guarantors as a means of securing finance. This effectively means that a third party, who would also be credit checked by the lender as part of your application, would take on your debts in the event of default. Again, this is not the first choice action which your lenders prefer. However, it is an option.
If you defaulted on your loan, and the situation was unlikely to change in the short term, your debt would be transferred to the guarantor. There are two options here:-
- The guarantor takes over future monthly loan payments
- The guarantor would immediately pay off all of the outstanding debt
When signing a loan agreement, you must be fully aware of the terms and conditions if you have future problems. This is not a pleasant thought, but it is sensible to know how your lender would react in the event of default. In addition, your agreement specifies how collateral and guarantors will be treated.
Most loan defaults do not necessarily require court action. Indeed, this is often seen as the nuclear option for a lender. It is a means of gaining legal powers to recover funds owed by whatever means. Many lenders prefer to use the services of debt collecting agencies when unable to come to an amicable agreement with troubled customers. Some countries also allow debt to be "sold on" to third parties who will use various tactics to recover as much money as possible.
In a perfect world, court action would not be the preferred option due to the expense and time it can take. Unfortunately, some customers are unwilling or unable to arrange a solution with their lenders. In this scenario, court action may be the only option.
On rare occasions, if unable to repay the outstanding loan, you may be declared bankrupt. This would then open the door for any other creditors to come forward and make a claim against your income and assets. Many people fear being made bankrupt due to loan defaults. In reality, these are relatively rare.
If the customer is not given more time to increase their income and dispose of assets, there can often be little left in the pot. This may see creditors receiving only a fraction of outstanding debts. As a result, all parties prefer to avoid bankruptcy proceedings where at all possible.
How to avoid loan payment defaults
The problem with loan payment defaults is that they can significantly impact your credit rating for some years to come. A formal loan default would likely affect your ability to raise finance to:-
- Purchase your own home
- Purchase a vehicle
- Start a business
Even if you are in a dire financial situation, you can still take action to try and mitigate long-term damage to your credit rating.
Let your lender know you are having issues
There are many common misconceptions when it comes to financing and, in particular, personal loans. The idea that approaching your lender when experiencing financial problems could lead to immediate termination of your loan agreement is wrong. There are specific procedures to go through, and you will find lenders surprisingly receptive to those who go down this path. These include:-
If your financial distress was a short-term issue, then your lender may agree to short-term payment holidays. While the missed payments would still attract interest charges, a period of reduced financial outlay could help you back on your financial feet. Of course, the lender would have to be persuaded that things were about to change. Payment holidays tend to be short-term arrangements.
There may also be an option to refinancing your loan over an extended period, resulting in lower monthly loan payments. Lenders would not take this course of action without evidence that you could cover these reduced payments. If there are problems that can' be resolved, refinancing your loan would be unlikely.
As a direct consequence of missed payments, you may be seen as a higher risk than at the time of your original loan application. Consequently, your lender would likely charge a higher interest rate to reflect this.
We tend to find that those who default on personal loan payments have other debts and other missed payments. In this scenario, it may be possible to put together a debt consolidation loan. This would bring all of the individual's debts under one loan, one monthly payment, and perhaps an extended repayment timetable.
Rather than covering minimum payments for five different debts, a consolidation loan would allow these debts to be repaid with only one monthly loan payment. This is a popular option for those experiencing short to medium-term financial troubles. Not only does it avoid further action by your lender, but lenders also benefit from the extended repayment period with additional interest.
Some people use collateral to secure finance, others to reduce their loan interest rate. However, many lenders are wary of some types of collateral, which may not necessarily be easy to liquidate. On the other hand, when sold relatively quickly, some assets would command a reduced price compared to their actual market value.
If you are experiencing financial difficulties, the use of collateral could open numerous doors. In effect, this would be your lender's insurance policy against future payment defaults.
While guarantors are often compared to collateral, they are very different arrangements. When looking to recover from your financial distress, the use of a guarantor would be welcomed by your lender. In effect, your debt is their debt in the event of you defaulting.
Unfortunately, we see many guarantors entering into such arrangements and automatically assuming the worst will never happen. Guarantors must be aware of their obligations and how quickly matters can change.
The idea that lenders will immediately come down hard on those who miss one, two, or even three payments is misguided. It is in the best interests of lenders to acknowledge and sort out any short-term financial issues their customers may be experiencing. There may be numerous options depending on your financial situation and the short, medium, and long-term outlook.
Even if you have yet to miss a loan repayment but fear there are financial troubles on the horizon, speak with your lender. Explain the situation, your concerns, and how these may impact your loan payments in the short term. If such difficulties did emerge, you and your lender would be in a position to react relatively quickly. On the other hand, if you leave it too late to talk to your lender, you will see your options significantly diminished.
Those who place their head in the sand and hope their financial troubles will magically disappear will likely emerge to an even more difficult situation.
Author’s Bio: Lori Wade is a writer who is interested in a wide range of spheres from business to entrepreneurship and new technologies. If you are interested in the technology or banking industry, you can find her on LinkedIn.