What Is a Car Loan in Default?

What Is a Car Loan in Default?
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Getting behind on your loan payments, especially a car payment, is never good. Most people need a car to go to work or school or make trips to the grocery store. So having your car repossessed because of missed loan payments can have catastrophic results.

What are the consequences of defaulting on your car loan payments, and what can you do to prevent this from happening? Let’s look at the alternatives.

When Is a Car Loan in Default?

When a loan is technically considered to be in default does not have a universal meaning. Depending on your loan agreement, default could mean not having made a payment in ​30 days​, ​60 days​ or ​90 days​. You could be delinquent on a loan payment and still not be in default. Even so, lenders have wide discretion as to when they can declare a loan in default and start making collection efforts.

What Happens if You Default on Your Auto Loan?

If your lender declares your auto loan to be in default, several things could happen.

Your Car Can Be Repossessed and Sold

In most states, a lender can repossess your car when your loan goes into default. The lender hires a repo company to pick up your car, often without any warning. They're not required to tell you when they're coming. This is the worst-case scenario.

You May Still Owe the Lender a Deficiency Balance

After your car is repossessed, the lender sells the car at the best possible price, usually at an auction. If your loan balance is higher than the sale price of the car, you may still owe the lender a deficiency balance. In addition, the lender may add on repossession fees, towing costs, storage costs and any additional fix-up costs to get your car in condition to sell.

Your Debt Could Be Sent to Collections

Unless you make a payment plan with the lender to pay off the deficiency, your account may be sent to a collections agency. When this happens, you'll get collection calls and letters in the mail demanding payment.

Your Credit Score Takes a Drastic Drop

Your credit score drops considerably with a loan default on your record. The lender reports the defaulted loan to the credit agencies, and the transfer of your account to a collections agency is also reported.

The repossession report and notice to the collection agency remain on your credit report for ​seven years​ and make it even more difficult and more expensive to get another car loan.

If you're planning on applying for a mortgage to buy a house, the drop in your credit score forces you to pay a higher mortgage rate for the next ​15 to 30 years​.

What Are the Alternatives?

Rest assured, lenders do not want to repossess your car. They would rather have your money than your car.

If they have to go through a repossession, everyone loses. The lender may not be able to collect the balance of the loan, and if there's a deficiency, that may not be collected either. You also lose, because now you have a repossession on your record, your credit score takes a hit, and you’ll find it difficult to get approved for a loan in the future.

Work Out a Forbearance Plan

Communication is the key. While it may be uncomfortable, the best course of action is to initiate a conversation with your lender as soon as you expect to be late in making a payment. Lenders have every incentive to try to work out some sort of payment agreement with you before resorting to a repossession.

Before starting negotiations with your lender, learn where you stand with the balance of your loan and the value of your car. If the loan balance is higher than your car's value, then you have fewer options.

On the other hand, if you have positive equity in your car, meaning the loan balance is less than your car's value, you have better options to work out something without taking a financial loss.

Explain your situation to your lender and let them make some suggestions. You might be able to come to an agreement on some type of forbearance program. If your financial difficulties are temporary, this approach may give you enough time to overcome your financial difficulties.

Even if you only have a few hundred dollars in your bank account, offer to make a partial payment as a show of good faith. Lenders are more likely to work with customers who are making an effort and trying to work something out.

Downsize Your Vehicle

If you think your financial difficulties will continue, the next option would be to sell your car and downsize to a cheaper, smaller or older car that would have lower monthly payments.

If you're taking this approach, give yourself plenty of time to sell your car to a private individual to get the best price. Trying to sell quickly when under the threat of an impending repossession puts you in a difficult negotiating position.

Of course, this approach only works if you have equity in your car. If you're “under water” with your car loan, you could end up with having to fund the deficit with a new loan on a less expensive car and having payments that aren't much lower.

Sell Your Car

If you can get by without a car, you could try to sell your car and have enough money to pay off the loan balance.

The best option to get the most for your car is to sell it to a private party. If you try to sell to a dealer, they're only going to give you wholesale value for it.

Refinance Your Auto Loan

If you still have good credit history, it might be possible to refinance your car loan for a longer term or at a lower interest rate, giving you lower monthly payments.

Voluntarily Surrender the Car

If all options fail and you know that the lender is going to repossess your car, you can minimize the financial damage by voluntarily surrendering the car. In this way, you avoid the fees the lender would pay to a repo company and pass on to you.

If you've been making late payments or even missed a few payments on your car loan, all is not lost. Lenders are not interested in repossessing your car and are more than willing to work with you on a repayment plan. The first step is to contact your lender, explain your situation and try to come to a mutually agreeable solution. You'll have more options if you take the initiative before the situation deteriorates to the point of defaulting on your loan.