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You lost your job several months ago and are struggling to make ends meet. Your unemployment checks cover rent and food, but not your car payments—and your savings are running out. What would happen if you stopped paying your car loan? When you stop making loan payments like you agreed to when you bought the car, it's called defaulting. Defaulting on a car loan results in derogatory marks on your credit report, which can have a severe negative effect on your credit score, and make it more difficult to get credit in the future.
What Happens When You Default on a Car Loan?
As soon as you miss your car payment due date, your lender could consider your account delinquent. The lender will usually charge you a late fee and will try to collect on the missing payment. You might have a short grace period, such as 10 or 15 days, during which time you can bring your account current without facing a late fee or other consequences. After 30 days, your lender will report the delinquent payment to the major consumer credit bureaus (Experian, TransUnion and Equifax), which add them to your credit reports.
The next step after delinquency is default. Each lender has their own timeline for declaring your loan in default; some may do it the first time you miss a payment, while others wait 90 days or longer. When you default, the lender ramps up their collection efforts, turning your account over to their in-house collection team or to a third-party collection agency that tries to recoup the money.
Consequences of Defaulting on a Car Loan
Defaulting on a car loan can have serious consequences for your finances that can last for years. Ultimately, defaulting can make it harder to get approved for credit, such as mortgage loans or credit cards.
A late payment can negatively affect your credit score. Because payment history is the biggest factor in credit scoring, accounting for 35% of your FICO® Score☉ (the most commonly used credit score among lenders), a single missed car payment can have a serious negative effect on your credit score. A delinquency on your loan payments will stay on your credit report for seven years.
Your car could be repossessed. When you get an auto loan, the car serves as collateral for the loan, meaning the lender can take the car if you're delinquent. Depending on your state's laws and the terms of your loan agreement, a lender may be able to repossess your car as soon as you miss one loan payment, and they may not have to give you any warning. More commonly, though, lenders will contact you seeking the missed payments before they take the drastic step of repossessing the car.
After repossessing a car, the lender typically sells it at auction to recoup the money you owe on the loan. If the sale doesn't net enough money to pay off your loan, however, the lender may turn to you for the rest of the money or even sue you to get it.
As for your credit score, having your car repossessed will further compound the negative impact of the delinquency and collection account on your credit history. A repossession is considered a serious derogatory mark on your credit report and will stay there for seven years.
Any remaining debt could be sent to collections. Even after your car is repossessed, you could still face calls, emails and letters from collections agencies. Lenders sell repossessed cars at auction, and if it doesn't recoup the remaining balance of the loan financing it, you'll owe what's called a "deficiency balance." Ultimately, the lender could sue you for the money you owe. Your wages could be garnished; a lien could be put on your home. Even if you pay off the debt, an account in collections remains on your credit report for seven years from the date of delinquency.
How to Prevent a Default on a Car Loan
If you're concerned you may not be able to make your auto loan payments, don't hide your head in the sand. Taking action can help protect your credit score. Here are some things to try.
Negotiate With Your Lender
When borrowers default on their loan, it costs lenders time, money and hassle, so lenders are often willing to work with them to find solutions. As soon as you start having trouble with your loan payments, contact your lender to discuss the situation. Reaching out first shows you're making a good-faith effort to resolve the problem, which may make the lender more willing to negotiate. It's best to do this before your payment due date.
Refinance Your Car Loan
If you have a good credit score and haven't yet missed a car payment, but fear you may do so, refinancing your car loan could be an option. Refinancing isn't done through a dealership but rather directly with lenders. If you're approved for an auto loan refinance, the new lender will pay off your existing loan and take title to the car from the original lender. Ideally, you want to refinance to a loan with a lower interest rate, lower monthly payments or both, which can make the debt more manageable.
Refinancing won't work for everyone, though. If you owe more on your car than it's worth or if your car loan includes a prepayment penalty, refinancing probably won't save you any money. If your car is over five years old or your credit score is lower than it was when you got the original loan, you may not qualify for a refi.
Consider Debt Consolidation
Another option is getting a personal loan to consolidate debt and pay off the car loan. This option works best if you're struggling with other debts (such as credit card debt), have a good credit score and have a plan to keep your debt under control.
Ask About Deferment Options
When you're granted loan deferment, the lender agrees to let you skip a car payment or pay only the interest that's due that month. You may be able to defer as many as three payments, but rarely more than that. If your loan agreement includes a deferment option, deferring can be as simple as choosing the "skip a payment" option online or in your payment coupon book. If not, you must submit a written hardship letter to the lender asking for deferment and explaining why you need it.
If the lender approves the deferment, they'll send you a forbearance agreement that specifies when you'll resume payments again and any fees or penalties for the deferment. Payments you defer get added on to the end of your loan repayment period and interest accrues on them. Deferment is meant to be a short-term solution for people in temporary financial difficulty. If you don't think you'll be able to manage your payments once the deferment ends, you should consider another option.
Find Someone Else to Take Over the Loan
Although most auto loans prohibit it, some lenders will let you transfer your auto loan to another party. You'll need to find someone with a good credit score who can qualify for loan terms similar to yours. If you have a candidate in mind, contact the lender to discuss this option.
Voluntarily Surrender the Car
If you know repossession is inevitable, you can soften the blow to your credit score a bit by voluntarily surrendering the car to the lender. This will still show up as a negative entry on your credit history, reflecting that you failed to repay a loan. However, its effects won't be quite as bad as a repossession, since it shows that you cooperated with the lender.
Avoid Defaulting on a Car Loan
When you're in financial trouble, defaulting on a car loan might seem like an easy way out. In reality, the negative effects on your credit score can linger for years, making it harder to achieve long-term financial goals such as buying a home.
Talking to your lender is the first step to avoid defaulting on your auto loan. Checking your credit score and report will help you determine if you qualify for options such as refinancing or debt consolidation loans, which often require good credit. You can get a free copy of your credit reports through AnnualCreditReport.com. You can also check your credit report and score for free through Experian. If you're struggling with debt or with your finances in general, a reputable credit counseling service can help you create a plan for getting out of debt and managing your money.