A car loan is a significant financial commitment, and missing payments can have serious consequences for both your finances and your credit history. When you take out a car loan, you enter into a legally binding agreement with your lender, which requires you to make regular payments for the duration of the loan term. Failing to meet these payment obligations can eventually lead to loan default, a situation that can result in severe repercussions.
In this article, we’ll explore what happens when you miss car loan payments, how the default process works, and what steps you can take to protect yourself from the negative effects of defaulting on a car loan.
What Is a Car Loan Default?
A car loan default occurs when you fail to make the required payments on your loan for an extended period of time. A car loan is a secured loan, which means the vehicle itself acts as collateral for the debt. This gives the lender the right to repossess the car if you fail to meet the terms of the loan.
Although the exact timing and terms for default may vary depending on the lender and the specifics of the loan, most car loans are considered in default after three to six months of missed payments. At this point, the lender will likely take action to recover the money owed, which can include repossession of the car and other legal or financial consequences.
What Happens If You Miss Car Loan Payments?
Missing car loan payments, even once, can set off a series of events that impact your finances. Here’s a breakdown of what happens if you miss a payment or several payments.
1. Late Fees and Penalties
The first consequence of missing a car loan payment is likely to be a late fee. Most car loan agreements specify a grace period for late payments, typically 10 to 15 days. However, if you fail to make the payment within that grace period, the lender will assess a late fee. These fees can range from $15 to $50, depending on the lender and the terms of your loan agreement.
Additionally, missing payments can lead to higher interest rates on the loan if your payment history becomes inconsistent. The lender may also report your missed payment to the credit bureaus, which can negatively impact your credit score.
2. Damage to Your Credit Score
One of the most immediate and lasting consequences of missing car loan payments is the damage it can do to your credit score. When you miss a payment, the lender typically reports the delinquency to the major credit bureaus (Equifax, Experian, and TransUnion). This negative information can lower your credit score, making it harder to obtain credit in the future and potentially resulting in higher interest rates on any new loans.
Late payments can remain on your credit report for up to seven years, even if you eventually catch up on your payments or pay off the loan. The longer your car loan is overdue, the more significant the impact on your credit score will be.
3. Increased Loan Balance
If you miss payments over time, the balance of your loan may increase due to accumulated late fees, penalties, and accrued interest. For example, if you miss a month’s payment, the lender may charge a late fee and add the missed payment amount to the principal balance. This can result in compounding debt, where you end up owing more than you initially borrowed. Additionally, continued missed payments may lead to the lender enforcing additional penalties, making it more difficult to get caught up.
4. Repossessions and Foreclosure
If your payments continue to go unpaid, the lender has the right to repossess the car. Repossession typically occurs after three to six months of missed payments, depending on the terms of your loan agreement. If the lender repossesses the car, they can sell it to recover the amount you owe on the loan.
However, the process doesn’t end there. If the sale of the car doesn’t cover the full loan balance, you may still be responsible for the remaining balance—this is known as a deficiency balance. For instance, if you owe $15,000 on the loan and the lender sells your car for $10,000, you may still owe the lender the $5,000 difference. In some states, the lender may pursue a deficiency judgment against you to recover the remaining debt.
Repossession not only puts you in a difficult financial situation, but it also severely impacts your credit score, making it harder to qualify for loans, mortgages, or even rental housing in the future.
5. Legal Action and Wage Garnishment
In the worst-case scenario, the lender may take legal action against you for failing to repay the car loan. If the car is repossessed and sold, but there’s still an outstanding balance, the lender can sue you for the deficiency. If the court rules in the lender’s favor, they may be able to garnish your wages or seize other assets to recover the outstanding amount.
Wage garnishment occurs when a portion of your income is withheld by your employer and paid directly to the lender. The lender must obtain a court order to initiate garnishment, but once it begins, it can be a significant financial burden. It’s important to avoid letting the situation escalate to this point.
How to Avoid Car Loan Default
While missing a car loan payment can have severe consequences, there are steps you can take to avoid defaulting on your loan and mitigate the impact of missed payments.
1. Contact Your Lender Immediately
If you anticipate that you might miss a payment or are struggling to keep up with your payments, contact your lender as soon as possible. Lenders are often willing to work with borrowers facing financial hardship, and many offer options such as payment deferment or modifying the loan terms. Some lenders may allow you to skip a payment or extend the loan term to make monthly payments more affordable.
2. Seek Financial Counseling
If you’re struggling with debt, consider speaking with a financial counselor or advisor. A certified financial counselor can help you create a budget, manage debt, and explore options to get back on track. Many non-profit organizations offer free financial counseling services to help individuals avoid the consequences of loan default.
3. Refinance Your Car Loan
If you’re facing high monthly payments due to a car loan with a high interest rate, refinancing your loan may help reduce your payments. By refinancing, you may be able to secure a lower interest rate or extend the loan term, making it easier to manage your monthly payments. Refinancing also gives you the chance to shop around for better loan terms.
4. Sell Your Car or Trade It In
If you find yourself unable to afford your car loan payments and refinancing isn’t an option, you may want to consider selling your car or trading it in for a less expensive one. The sale of your car can help pay off part or all of your loan balance, preventing the need for repossession. Keep in mind that selling the car will only help if you can sell it for an amount that covers your loan balance.
5. Stay on Top of Payments
The best way to avoid default is to stay on top of your car loan payments. Set up reminders for payment due dates or automate your payments to ensure they are made on time. Keeping up with your payments not only helps avoid default but also preserves your credit score and financial reputation.
Conclusion
Defaulting on a car loan can have serious consequences, including damage to your credit, repossession of the vehicle, and potential legal action. However, there are ways to avoid default by staying on top of your payments, communicating with your lender, and exploring options like refinancing or selling your car. If you are already behind on your payments, the most important step is to act quickly—contact your lender and seek financial help to prevent the situation from escalating. By taking proactive steps, you can protect yourself from the severe consequences of loan default and regain control of your finances.