Updated Feb 20, 2022

What is Default?

What is Default?

Introduction

The exact definition of “what a payment default is” varies from situation to situation. However, the basic term “default” indicates the inability of a debtor to repay a certain sum of money he has borrowed or the payment of a wrong amount to the creditor, which can result in a default notice. For example, when it comes to individual lenders, a single non-repayment can result in default. However, for a financial institution to default, the number of payment instalments they can default on is three.

In simple words, when the loan money is given to one or more individuals or companies by banks or any other financial institution to manage their expenses. In this case, the borrower incurs a debt to the creditor and is expected to pay back with a certain amount of interest in a given time frame. The failure of the debtor to pay the total amount back is known as default.

What is a Default Notice?

When a debtor breaks the terms of a debt loan agreement, the creditor may decide that the chances of the money coming back are little to none. This leads the creditor to cancel the agreement, resulting in a default notice. Debts can default only once, and after a second default, it is the creditor’s right to take further action.

A default notice is an official document sent to the debtor informing him that he is behind on his payments and is at the risk of defaulting on them. The time period given in a default notice is generally two weeks, after which any inability to pay the amount will result in a defaulted account.

What is An Event of Default?

An event of default is a clause in a contract between a creditor and debtor that allows the creditor to demand the full payment of an outstanding amount before it is due. This is actually a precautionary measure the lender takes to ensure that he gets his money back. An event of default can also be agreed upon if the borrower does not have enough finances to pay back the loan or does not intend to do so in the future. This clause allows the creditor to collect any documents related to the agreement and sell them so that the loan is repaid in full.

The event of default clause permits the creditor to exercise his rights and confront the borrower about the amount owed. Although, in theory, the payment can be demanded immediately, in practice, this rarely happens. In most cases, the contract is rehashed, and the terms are changed to higher interest rates and shorter repayment times and amendment fees.

What Happens When Debtors Default?

Before the creditor considers the payment default, the borrower has one last opportunity to repay the amount or enter a settlement of his choice and agree upon it. This, however, tarnishes the borrower’s reputation and market standings. A default on debt can have consequences like:

1. Revaluation of the borrower’s assets
2. Decrease in the faith of the creditor to get the loan back
3. Decrease in debtor’s investments
4. Chances of additional borrowing by the debtor
5. Legal implications for the debtor related to the defaulted payment

How Do Defaults Differ Between Secured Loans and Unsecured Loans?

Depending on the type of debt, creditors can recover their money in two ways. In the case of a default on a secure loan, the creditor can sell the debtor’s securities attached to the loan with prior intimation to the debtor. In this case, the creditor stands to lose less money. In the case of a default on unsecured loans, however, the loss to the creditor is much more, and a case is filed, or a new settlement is made between the creditor and debtor.

Conclusion

Any default on the part of a debtor is not a good thing. Although different types of loans have different implications, it is essential to know that it is imperative to find the resources to pay the creditor back, no matter the amount. Many times, default rises from a lack of finances on the debtor’s part. With a default notice, a debtor can still have a chance to pay back his loans; however, if he fails to do that, it could result in a legal case which could mean more expenses and borrowing.