Consequences of Defaulting on a Car Loan

If you’re struggling to make car payments, you’re not alone.

According to the Federal Reserve Bank of New York data, 1.72% of all auto loans went into the “seriously delinquent” category^[1] in the first quarter of 2021, meaning borrowers’ payments were 90 days or more past due.

When you stop making payments as agreed to on your auto loan for an extended period, your loan goes into default. A default can severely impact your credit score, making it difficult to get credit in the future.

Here’s what you need to know about what happens if you default on your car loan and what you can do to prevent it.

What happens if you default on your car loan?

So, does buying a car help your credit? It can, however, you should make sure that you make payments on time to avoid defaulting on your car loan. So if you default on a car loan, what happens? As soon as you miss one car payment, your loan is considered delinquent. You can usually get your loan out of delinquency by catching up on your payments and possibly paying a late payment fee.

If your loan remains delinquent, however, it can go into default. The timeline for default depends on your loan terms as well as state law. In some states, lenders can declare your loan in default the first time you miss a payment. In other states, your payment may have to be 90 days late or longer.

Once your car loan goes into default, the lender typically steps up collection efforts by referring your account to their in-house collection department or an outside collection agency.

Consequences of defaulting

Defaulting on a car loan won’t lead to arrest or jail time, but it can have serious consequences, including:

• Your credit score will go down. Payment history is one of the major factors in credit scoring, accounting for 35% of your FICO Score^[2] . So late payments and loan defaults can negatively impact your credit score.
• You could lose your car. Both a traditional car loans and car title loans are secured by the vehicle, meaning the lender may be able to repossess the car if you default on your loan. Car repossession laws vary from state to state. According to the Federal Trade Commission (FTC)^[3] , in some states, lenders can repossess your car as soon as you default on the loan, while other states don’t allow car repossession at all. Review your loan agreement to learn more about what happens if you default on your car loan.
• The lender may send your account to collections. Having your account “sent to collections” means the original auto lender gave up on trying to collect a debt from you and sold it to a third-party collection agency. The collection agency then tries to collect the debt. Having collections accounts on your credit report will almost certainly lower your credit score, and collections remain on your credit report for seven years.

How badly will defaulting on my car loan affect my credit?

Having one car loan payment go more than 30 days delinquent can hurt your credit score, and the longer your payment is late, the greater the potential impact on your credit score. Payments that are 60, 90, or 120 days late have a greater impact on your score than those that are 30 days late.

Having your defaulted account sent to collections further damages your credit. The collection account is reported as a separate account on your credit report. The original account typically appears on your credit report as a “charge off,” meaning the original creditor gave up trying to collect the debt.

The actual impact of a car loan default depends on your overall credit profile. Credit bureaus use several factors to calculate your credit score, including your loan and credit card payment history, the total amount owed, and how long you’ve been using credit.

But late payments, charge-offs, collections, and other negative information remain on your credit report for up to seven years from the date the debt first became delinquent.

Can I prevent defaulting on a car loan?

Before skipping a car payment, try reaching out to your auto lender to explain the situation. Many lenders have options to help borrowers dealing with job loss, medical emergencies, and other financial hardships.

According to the Consumer Financial Protection Bureau (CFPB)^[4],

"The sooner you contact your lender, the more choices the lender may be able to offer you. And since it’s more often expensive for a lender to repossess your car than to work with you, your lender may be able to offer options to help you make your payments."

Some of those options may include:

• Extending your loan term
• Deferring your car payment for up to three months
• Offering a payment plan to help you catch up on missed payments

Reaching out before missing a payment shows the lender you want to avoid delinquency and default, making the auto lending company more willing to work with you.

How can I recover from defaulting on a car loan?

If your car loan goes into default and the lender repossesses your car, you typically have a short period to try to reclaim it. However, the only way to reclaim the car is to pay off the loan balance and any repossession costs.

If you’re having trouble making your car payments, then paying your loan in full may be impossible. For that reason, it’s best to try working with your lender early — before missing your first payment, if possible — to avoid default rather than trying to recover a defaulted loan.

What is the statute of limitations on a defaulted car loan?

After repossessing your car, the lender may sell it privately or at a public auction. If the sale doesn’t net enough money to pay off your loan in full, you could still owe your lender money. This is known as a “deficiency balance.” If you don’t have the money to pay the deficiency balance, the lender can take legal action to collect the remaining debt.

The statute of limitations for collecting that debt ranges from three years to 10 years, depending on your state’s laws. This doesn’t mean the lender or collection agency can’t attempt to collect the debt beyond the statute of limitations. It just means they can’t file a lawsuit against you. Technically, you still owe the money.

Can I refinance a defaulted car loan?

Refinancing your car loan may be a good option for avoiding default, but it might not be an option once your loan goes into default. Late payments, charge offs and collections lower your credit score, which could make refinancing tough.

If possible, try to refinance your car loan through your current lender or another lender before missing a payment. You may be able to qualify for a lower interest rate or longer loan term, which could lower your monthly payment to a more affordable amount. Just keep in mind that an extended loan term can lead to paying more interest over time, and put you at risk of being upside down on the loan.

If refinancing isn’t an option, consider getting out of your car loan another way. You may be able to trade in your car for a more affordable one or sell it to pay off the loan. This will help you avoid default and protect your credit rating.

When you’re dealing with financial hardship, skipping a car payment or two might seem like an easy way to come up with the cash to cover other necessary expenses. But defaulting on a car loan can have serious and long-lasting consequences for your finances. For that reason, it’s a good idea to try working with your lender to avoid default and prevent further damage to your credit rating.

Article Sources

1. Federal Reserve Bank of New York. “Credit Card Balances See Second Largest Quarterly Decline”. https://www.newyorkfed.org/newsevents/news/research/2021/20210512. Accessed July 8, 2021
2. myFICO. “What’s in your credit score?” https://www.myfico.com/credit-education/whats-in-your-credit-score. Accessed July 8, 2021
3. Federal Trade Commission. “Vehicle Repossession.” https://www.consumer.ftc.gov/articles/vehicle-repossession. Accessed July 8, 2021
4. Consumer Financial Protection Bureau. “Worried about making your auto loan payments?” https://www.consumerfinance.gov/about-us/blog/worried-about-making-your-auto-loan-payments-your-lender-may-have-options-to-help/. Accessed July 8, 2021

About the author

Janet Berry-Johnson is a Certified Public Accountant and freelance writer with a background in accounting and insurance. Her writing has appeared in Forbes, Freshbooks, The Penny Hoarder, and several other major outlets. See Janet on Linkedin and Twitter.

About the reviewer

Lauren Bringle is an Accredited Financial Counselor® with Self Financial– a financial technology company with a mission to help people build credit and savings. See Lauren on Linkedin and Twitter.

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