3 Ds: Understanding the difference between deferment, delinquency and default
Deferment, Delinquency and Default
- Deferment allows you to skip payments on your loan, but the balance still must be repaid.
- Delinquency occurs when you miss a payment on your loan.
- An account goes into default when it has been delinquent for a prolonged amount of time.
- Once defaulted, the lender may repossess any collateral used to back the loan.
When it comes to borrowing money, many phrases get thrown about, and to the uninitiated, they can all start to blur together.
Deferment, delinquency and default are three lending phrases that all sound similar. Each of these phrases pertains to borrowers who are unable to make payments on their loans. These terms are used in most borrowing transactions, including mortgages, student loans and credit card debts, as well as for secured and unsecured loans. Each term has a distinct meaning, and should not be confused with the others. Here are explanations of each term to help guide you on your lending journey.
Deferment is a term most commonly used in relation to federal student loans, although deferment can also be applied to other types of loan payments, such as mortgages.
Under certain circumstances, the borrowers of federal student loans may temporarily stop making payments, or make reduced payments, without penalty. This is called deferment or forbearance.
Payments on other types of loans, such as mortgages, can sometimes be deferred if, for instance, the borrower is experiencing temporary financial hardship. Such deferments typically must be arranged with the lender on a case-by-case basis.
Regardless of the debt type, if you know you’ll have trouble making a payment, contact the lender as soon as possible and explain your situation. Most will work with you.
If you fail to make payments on your loan, your loan becomes delinquent. In other words, when someone has a contractual obligation to make timely payments on a loan, but doesn’t make those payments on time, the loan becomes delinquent. If the payments are not brought up to date within a certain time period, the account goes into default and the lender can move forward with foreclosure proceedings.
Typically, lenders won’t report delinquencies to credit-reporting bureaus until the delinquent account is 30 days past due. Sometimes lenders won’t report a delinquency until the borrower has missed two consecutive payments.
Delinquencies can remain on your credit report for as long as seven years, so it is prudent to address late payments before they are reported as delinquencies.
Once your loan has been delinquent for a certain period of time, the lender will declare your loan to be in default. The exact period of time before the loan goes into default varies depending on a variety of factors, including the loan type and the state the borrower lives in. Most federal student loans, for example, are not considered in default until the borrower has failed to make payments for nine months, where a credit card may take four months. Defaulting on a loan can harm your credit rating and make it more difficult to borrow money in the future.
If your loan is secured by some form of collateral, such as a car or a house, going into default typically allows the lender to take possession of the collateral. In the case of a home, the process of the lender taking possession of the home is called foreclosure. In the case of a car, and many other forms of collateral, it is called repossession. When you default on credit cards or student loans, lenders generally involve collection agencies.
Some states have laws that limit when lenders can retake possession of collateral. It is prudent, however, to know your state’s laws before taking out a loan that could cause you to lose your car or house if you fail to make payments.