How Does Defaulting on Your Car Loan Affect Your Credit Rating?

Defaulting on your car loan is costly and will affect your credit rating for years to come. There are a number of financial penalties associated with a default. Even after you have met the obligations of a default, you will find your credit score has dropped significantly, and you will have a hard time finding another loan opportunity in the near future.

Financial Costs of Default

When you default on an auto loan, you will face repossession of the automobile. This comes at no small cost. A "repo" agent will track down your car. The agent will repossess the vehicle and charge a very high fee to the lender for doing so. The lender will pass this fee right on to you. Then, the lender will attempt to liquidate the car. The lender will incur costs to list the car at auction, which will be charged to you. Finally, the lender will charge the difference in the sales price and the remaining sum on the car loan to you. You may find default is more expensive than just making your payments would have been.

Credit Problems after Default

Defaulting on a loan is breaking a legal contract. The lender will report you to the credit bureaus for breaking the contract, and you will have a report on your credit score for at least 5 years and maybe longer depending on your state. In addition, there will be several actions against your credit in the meantime. Each time you are late on a payment, which will happen a lot on the way to default, the lender will knock your credit down lower. The result is an extremely compromised credit score by the time the repossession is finalized.

Avoiding Default

The best way to avoid these penalties is to avoid default completely. If you cannot make your payments, contact your lender immediately. Consider your options to refinance the loan. You may be able to defer payments in a hardship or even enter a period of forbearance if you are recovering from an emergency. It is even better to attempt to sell the car yourself and pay this sum plus the remainder of your loan to the lender than to enter default. This is similar to a short sale on a home, and it allows you to minimize financial losses as well as credit losses.

Mitigating Losses

At the end of the day, default may not be avoidable. However, you can control the degree to which default will harm you. Enter default and repossession voluntarily. Return you car to the lender instead of allowing a repo agent to take this step. Submit the car long before you have entered the default stage, and you will see less of a score drop due to missed payments. Ultimately, you will still have some credit problems, but you will avoid a lot of stress and additional financial losses on the loan.

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