Default is the inability of any subject to pay debts to creditors on time. The objects of default can be both the state and private companies, as well as ordinary people. Default is not the same thing as bankruptcy, which is a consequence of a default, formally confirming the complete inability to repay the debt. In the case of companies, default is a pre-bankruptcy condition. At the country level, the default probability is determined by the ability of public financial institutions to service public debt, which is basically expressed in special securities –government bonds. Default risk is an essential component of credit risk and a meaningful factor for creditors.
The lender has the right to sue the borrower if the established payments are not received on time, and then the most important condition will be whether the debt is secured or not.
Thus, a secured debt is a debt secured by real property or assets (for example, auto loan or mortgage). The creditor can confiscate the borrower's property in case of default, sell it and use the funds to pay off the outstanding debt.
In the opposite, an unsecured debt has a different principle—the guarantor of payments is only the rating of the issuer (examples: student loan, credit card balances). In this instance, default will play an important role in a customer's credit history, blocking his access to future loans. Since the risk level of an unsecured loan is much higher, it always has higher interest rates too.
The third party in the default process with an unsecured debt is a collection agency. When a payer defaults on the debt, the creditor will report this delinquency to a credit rating agency. This debt will be transferred to a collection agency within 6 months of default (in some cases 3 months), which would then attempt to recover it from the borrower.
Student loan Default
Before federal student loans default, they enter a status known as delinquency. Loans are considered delinquent when the payments had not been received on time, but information about it is transmitted to credit agencies until 90 days have passed. After that, the credit rating goes down. The lower the credit rating score, the more difficult it is for a person to get a new loan on profitable terms. In addition, it is important when applying for a job, as potential employers will check the candidate's credit rating in the majority of cases.
If student loan payments are overdue 270 days, the next step comes, which is called the default. The U.S. Department of Education holds the majority of such loans.
As a COVID-19 relief measure, the government suspended federal student loans from entering default and paused collection activities on those that already had. These measures are valid through Nov. 1, 2022. Payments are paused on all student loans through Aug. 31, 2022. During this time, students can get loans back in good standing with loan rehabilitation and consolidation.
A sovereign default is the same default, but at the national level. The reason for declaring a default at the state level can be not only financial insolvency, but also political reasons, such as regime change or leadership transition.
As a rule, this phenomenon is accompanied by a severe decline in most sectors of the economy and may lead to the devaluation of the national currency. The defaulted country is not allowed to the debt markets of the world for a long time.
Consequences of a Default
- In the event of a default on loans, a low credit score affects obtaining credit in the future and the possibility of obtaining a new loan is reduced to zero.
- Credit organizations will offer loans on extremely unfavorable terms (higher interest rates) in connection with the decrease in confidence in the debtor.
- At the state level, unstable economy, unemployment, loss of production and decreased incomes of people are the main results of the default.