What Does it Mean to Default on Debt?

When you default on a debt, you’ve breached the loan agreement – often by missing one or more payments. Individuals, businesses, and countries can all default on their debts.

What does it mean to default on debt? 

Defaulting on a debt means you’ve violated the terms of your debt agreement or loan contract. 

Borrowers most often default by missing payments. Some loans are considered “in default” after a single missed payment, while others enter default after several months. 

Creditors can also default, usually by failing to deliver the goods or services outlined in the contract. (For instance, a mining company may default on its futures contracts if it can’t produce enough metal ore.)  

What happens if you default on a debt?

The impacts of defaulting on a debt vary between contracts and entities. Common consequences include a lower credit rating, garnished wages and lawsuits.  

Individual borrowers

Individuals can default on three distinct types of debts:

• Secured debts like mortgages or margin loans “secure” the debt against a valuable item. If you default, lenders can seize this item to pay your balance. 
• Unsecured debts like credit cards don’t “secure” debts, but lenders still have a legal claim in default. They may sue, garnish your wages or sell the debt to a collection agency. 
• Federal student loans are unsecured loans backed by the U.S. government. Defaulting on a federal loan is unfortunate because they’re often not forgiven in bankruptcy. Even if you default, you have to pay up. 

Defaulting on personal debts almost always puts a black mark on your credit report. This lowers your credit score and makes future financing harder (and more expensive) to get. You could also face repossession, foreclosure, garnished wages or bankruptcy.

Business borrowers

Businesses may default on their debts by failing to make payments on loans, shareholder bonds or futures contracts. Typical consequences of a business default include:

• A lowered credit rating that jacks up interest rates on new bonds
• Heightened lender oversight, including correction plans
• Implementing automatic payment controls

In severe cases, a business may need to fire employees, liquidate assets or file for bankruptcy to resolve its debts. 

Government borrowers

Government (sovereign) default occurs when a country can’t pay businesses, employees, contractors, pensioners or bondholders. You often hear whispers of default when the U.S. government hits the debt ceiling. 

Unlike other debtors, courts can’t compel payments from defaulting countries. Instead, nations may face consequences like:

• A lower credit rating
• Fewer investors willing to buy government bonds
• Higher interest rates on newly-issued government debts
• Devalued currencies
• Economic recession

While the U.S. has never defaulted on its debt, it’s not unprecedented. In 2015, Greece defaulted on a $1.73 billion loan, while Puerto Rico missed a $58 million bond payment.  

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Defaulting on a debt can come with major repercussions – which is why it’s better to avoid debt in the first place. 

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