How Auto Loan Default Impacts Your Credit History and Score[yoast-breadcrumb]
How Auto Loan Default Impacts Your Credit History and Score
Defaulting on an auto loan can be really stressful and worrisome. I totally get it–I’ve been there myself. When money is tight, making those monthly car payments can feel impossible. But before you stop paying your auto loan, it’s important to understand how defaulting will impact your credit history and score. Let’s break it down together so you can make the best decision for your situation.
What is Defaulting on a Car Loan?
When you take out a car loan, you agree to make regular payments over a set period of time (usually 3-6 years). Defaulting means you’ve failed to make those payments as agreed. After just one missed payment, your loan is considered delinquent. But defaulting typically happens after you’re 90 days late or more. At that point, the lender will usually repossess your car.
Defaulting is different than voluntarily surrendering your car to the lender. With voluntary surrender, you’re proactively communicating with the lender and turning in the car before defaulting on the loan. This looks better to potential future lenders than defaulting.
Your Credit Score Will Plummet
The biggest impact of defaulting on your auto loan is a plummeting credit score. Your credit score plays a huge role in your ability to get loans, credit cards, rent an apartment, get utilities connected, and sometimes even get a job. The higher your score, the better.
Payment history makes up a whopping 35% of your credit score calculation. Every late payment is reported to the credit bureaus. Just one 30-day late payment can drop your score by as much as 110 points! Once you default, your score can fall by over 200 points. Ouch.
In addition to the late payments, the repossession itself will be added to your credit report. This also dings your score. The default stays on your report for 7 years. That’s a long time to recover from the credit damage.
Future Loans Will Be More Expensive
That plummeting credit score doesn’t just hurt your pride. It actually makes future borrowing much more expensive. Lenders view borrowers with lower credit scores as high-risk. They charge significantly higher interest rates to offset that risk.
For example, let’s say you want to take out a $20,000 auto loan. With an excellent credit score (760+), you may pay around 5% APR. But with a poor score (580 or below), your interest rate could be 15% or higher! That’s a difference of over $2,000 in interest charges each year.
Higher interest on cars, mortgages, and credit cards really adds up. Defaulting on your auto loan starts a vicious cycle where low credit leads to high interest leads to more credit damage. It takes diligence to break out of that cycle.
You May Struggle to Get Approved
In addition to higher rates, a damaged credit score makes it harder to get approved at all. Lenders want to see that you reliably pay your debts. Defaulting on your auto loan signals the opposite. Many lenders will outright deny applicants with a recent default on their record.
You may have trouble getting approved for cars, mortgages, apartments, credit cards, utilities, cell phone plans, and more. It can be a huge hassle trying to find companies willing to take a risk on you.
If you do manage to get approved, you’ll likely need a cosigner with better credit or have to put down a large deposit. These extra requirements create barriers to accessing credit when you need it.
The Lender Can Sue You
When you default, the lender has to eat the cost of any remaining loan balance. Needless to say, they aren’t happy about losing money. Many lenders will sell the defaulted debt to a collections agency.
The collections agency will aggressively pursue repayment through frequent phone calls, letters, and lawsuits. If they win a judgement against you in court, the agency can garnish your wages, put liens on your property, or levy your bank accounts.
Wage garnishment means they can force your employer to withhold part of your paycheck to cover the debt. This is a huge financial stress on top of already tight money.
You May Owe Extra Fees
Defaulting often comes with added fees and penalties. First, you’ll owe late fees that accumulate each month you’re behind on payments. The repossession process also involves fees like towing, storage, auction, court costs, attorney fees, and more.
If the car sells at auction for less than what you owed, you’re on the hook for the difference. Gap insurance can protect against this, but not everyone has it. Added together, fees can inflate the amount you owe significantly.
Even after defaulting, interest and fees continue growing until the account is paid in full. This growing balance makes it harder to eventually repay the debt.
It May Impact Your Employment
As mentioned earlier, some employers check your credit before hiring. They want to see you’re financially responsible. Too much negative credit history could cost you the job.
Even once hired, wage garnishment due to collections lawsuits will be visible to your employer. They may see this as a red flag and grounds for termination. After all, they don’t want debt collectors contacting their place of business.
Losing reliable income from your job makes repaying debts even harder. It can turn into a downward spiral.
You Lose Your Car
With default, the lender will repossess your car and sell it to recoup their losses. You’ll have to figure out a new transportation solution.
Losing your vehicle can majorly disrupt life and finances:
- You may not be able to get to work, school, childcare, etc.
- Uber or public transportation costs pile up fast.
- Without a car, you’re limited on housing and job options.
- Buying another car will be very expensive due to your credit.
Voluntarily surrendering the car is slightly better since you avoid some repossession fees. But either way, defaulting means losing your wheels.
It Stays on Your Credit Report for Years
Unfortunately, the negative impact of defaulting sticks around. A defaulted auto loan remains on your credit report for 7 years from the date you first missed payments. The repossession itself stays on for 7 years from the date the car was taken back.
That’s a long time to carry around the credit damage! Even after it finally falls off your report, you still have to convince lenders you’re now responsible. Full credit recovery takes diligence and patience.
What Are Your Options If You Can’t Pay?
If you’re struggling to make payments, consider these options before defaulting:
- Refinance the loan – You may be able to lower your monthly payment by extending the loan term or reducing the interest rate.
- Sell the car – You may be able to sell it for enough to pay off the loan. Then buy a cheaper used car.
- Voluntarily surrender – Proactively communicate with the lender and return the car before defaulting.
- Trade it in – The equity can help pay off your current loan so you can start fresh.
- Defer payments – Ask the lender if they offer temporary hardship programs.
- Credit counseling – Get help negotiating with the lender and improving your finances.
If you’ve already defaulted, continuing to communicate with the lender shows good faith. Avoid dodging their calls and letters. Be proactive and explain your situation. They may be willing to create a payment plan, settle for less than the full amount, or agree to take the car back voluntarily.
Rebuilding your credit after default takes time but is possible! Just make all future payments on time, keep balances low, and wait patiently for the default to fall off your report.
I hope this breakdown helps you understand how defaulting on your auto loan impacts your credit and finances. Please reach out if you need help getting back on track! There are always options, even when things seem hopeless. You’ve got this!
Here are the references cited in this article:
- How Bad is it to Default on a Car Loan? – Experian
- 3 Tips If You’re Facing Auto Loan Default – Credit Karma
- Auto loan delinquencies rise. What to do if you struggle with payments – CNBC
- Consequences of Defaulting on a Car Loan – Self. Credit Builder.
- What happens when you default on a car loan | finder.com
- What Are the Effects of an Auto Loan Default? – Upsolve