What are the Consequences of Defaulting on a Personal Loan?

Consequences of Loan Default 

1. An Increase in Debt

   This may seem surprising, but defaulting on a debt will actually increase your overall debt. This is because when a default happens, the lending institution will charge you higher interest until the monthly payment is made. Further, you will need to pay penalties or fees for defaulting. 
    
   This is one of the main reasons why defaulting is so problematic. Suppose you face a liquidity crunch and cannot repay your loan on time, you will need to pay a significantly higher amount later on. 
    
   This can lead to a cycle of ever-increasing debt. People can find themselves repaying the interest and penalty on a loan for years because they missed a few payments in the beginning. 

1. Your Credit Score Nosedives

   The credit score determines how credit-worthy a person is. A person with a high credit score can get a personal loan much more easily than a person with a low credit score. The credit score tells lenders whether a loan applicant is likely to be able to repay the loan on time or not. 
    
   The credit score is calculated and published by credit ratings agencies. These agencies are responsible for checking your financial records and lending institutions get a person’s credit score from them. 
    
   If you default on even one payment, then your credit score will become much lower. This will impact your ability to receive credit in the future. Your personal loan eligibility will be less in the future. 

Also Read- What to do in case you can't pay your EMI or loan amount due
 

1. Possibility of Legal Action 

   If a person does not answer their lender's messages or if they consistently default on their loan, then the lender may start personal loan defaulter legal action. The lender can approach the Debt Recovery Tribunal in order to file a claim against you. These tribunals have been specially established to help with debt recovery cases. 
    
   The consequences of legal action can be very damaging. The court may direct you to repay your loans along with any penalties. It may attach your property. It may even hold you criminally liable which means that you could go to prison. 
    
   It is important to avoid legal action at all costs. If a person does find themself facing legal action, then it is best to hire a good lawyer. 
    
   Some of the types of legal actions that a lender can take include a summary suit under the Civil Procedure Code or a criminal charge under the Negotiable Instruments Act.

1. Impact on Mental Health 

   Defaulting on a personal loan will almost certainly impact a person’s mental health and mental peace. If a person does not repay their loan on time, then they will start receiving numerous calls from their lender. Certain lenders often send bank personnel to the defaulter’s residential or commercial address to pressurise the person to repay their loan amount. In such cases, the overall impact on mental health can be devastating. 

1. Impact on Relationships 

   Usually, people try to hide the fact that they have defaulted on a loan. But if a person has been in default for a long time, then it becomes harder to hide. When friends and family know that a person is in default of their loan, then it can negatively impact the relationships, causing turmoil and mental trauma.
    

How to Handle a Default Situation? 

 
If a person finds himself in a default situation, here are three ways to resolve the crisis.
 

• Debt Consolidation Plan

  Debt consolidation, as the name suggests, allows you to merge all the credit you have taken into a single monthly payment. Sometimes debt consolidation plans also allows you to repay your loans at a lower interest rate. This can be used to pay off your credit and your personal loan in an easier way.

• Do Not Ignore The Lending Institution 

  The worst thing that a defaulter can do is to start avoiding or ignoring the lending institution. Ignoring the debt recovery personnel will only make matters worse. This is because the lender will start panicking and believing that they will never receive another repayment again. Hence, it is much more likely that the lending institution will send you a legal notice if you don’t take their calls. 

• Explain Your Situation 

  If a defaulter is in genuine difficulty, then they should try to explain the situation to their lending institution. Usually, lending institutions understand that a person can face temporary financial difficulty and inability to service their loans.  In such circumstances, the best thing to do is to ask for more time to be able to service the loan. 

• Try to Negotiate

  Lending institutions understand that making regular monthly payments may not always be possible. They have faced this situation many times in their business. Hence, they are always ready to negotiate with the defaulter as long as the case is genuine. A defaulter should try to negotiate with the lending institution in terms of how much penalty he has to pay and the timelines for repayment. 
   

Also Read- How to Manage Your Personal Loan More Effectively

Wrapping Up 

A personal loan is an unsecured loan that is offered based on the payment ability of the borrower. Hence it’s very important that you do not default on payments. While loan default consequences can vary from case to case, and not every default will be met with legal action, it’s important to avoid defaulting on a loan.  Also make it a point to recognise when you are slipping into the default zone, stop and get back on track. Even better, know how much you can afford and take a loan only if you can afford to pay it back.