What Happens When You Default On A Loan? 

You might be worried about not being able to pay your loan debt and concerned about what will happen next. You’re not alone! Each month, over 170,000 people visit our website to get guidance on how to deal with debt.

In this guide, we’ll explain:

• What it means to default on a loan.
• The legal steps a lender can take to get their money back.
• How defaulting on a loan affects your credit score.
• If you can write off some of your debt and how to do it.
• When is a debt too much, and what can be done about it.

In 2022, arrears on household bills increased by 68% from £1,739 to £2,920¹. So, it’s quite common for people to struggle with debt. If you find yourself in this situation, don’t worry.

We’re here to help you understand what happens when you don’t pay a loan and how to handle it.

What happens when you go on a loan default?

There are a number of ways that the bank makes money when you default on a loan.

Firstly, remember that the bank will only ever lose about one twelfth (about 8%) of the loan, because that’s all it needed to have of its own money in the first place.

So even if you defaulted in the very first month, the bank would only lose 8% of the whole loan value.

If you have been keeping up with your installments for a number of months, the chances are that you will have paid back the bank all of the 8% it had originally invested.

So if you default on your loan, the chances are that the bank will have had all its “real” money back anyway, and a whole lot more, plus interest.

But it still expects you to pay back the other 92%. And it knows that the current law will back it up.

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The bank is allowed, by law, to pursue you for the whole amount.

It may well start doing this from its own debt recovery department. If that fails it will write off the debt and sell it to a debt purchasing company (DPC) or use a debt collection agency (DCA) on a commission basis.

At the same time it will receive a payment from an insurance policy which was taken out when the loan was first authorised.

Because, on top of your repayments and on top of your interest you will also (perhaps unwittingly) have been paying a monthly insurance premium – directly or indirectly – to be paid when the loan defaults.

Not paid out to you (though you have paid the premiums directly or indirectly) but paid to … you’ve guessed it … the bank!

So the bank gets paid a lump sum by the insurance company whenever a loan defaults and is written off.

There are also tax breaks which will benefit the bank when a loan is written off, as this counts against the bank’s tax bill on its profits.

Then there is the tidy little sum that the bank will make when it sells the debt on to a debt purchasing company.

DPCs buy debts, sometimes individually but more usually in bundles, for mere pennies on the pound. So a £10,000 debt will typically be bought by a DPC for £400. The DPC may then pursue you, using both legal and illegal means, for recovery of the whole £10,000.

And if you thought that the banks were making a good deal by their 92% + interest profit margins, then just look at what the debt purchasers are making!

If the DPC buys a bundle of debts for £10,000 it will mean that, at 4%, the total original value of the debt would be £250,000. It will then try to recover all of this.

Of course, it won’t be able to, as the debtors will not be in a position to repay what they owe.

They defaulted on the loan in the first place, after all. Their circumstances may have changed completely since first signing their credit agreement.

All sorts of things could have happened including unemployment, bankruptcy, divorce, disease, insanity and any number of personal disasters unique to the individual debtor. So most of the money will never be able to be collected.

But the DPC will be able to recover some of this, and so make a healthy return.

At only 4% investment it would be difficult not to make a profit! However, in order to do this the DPC’s sales staff will try every dirty trick in the book to maximise its profits.

All its sales staff will be paid (entirely or mainly) on commission, so everything will be geared up to screw the unfortunate debtor as much as possible.

They will phone you up and lead you to believe they are calling from the bank.

They will try to break your will and use all the tricks that salesmen know about (they are essentially, for the most part, very good telesales people) to make you part with your money then and there.

(Incidentally, this is why you should never speak to a DPC on the phone.

Always insist they put everything in writing and politely close the telephone conversation when they ring you up. The reason for this is that they know that they can get away with saying things on the phone that they can never get away with in print.

It’s also the reason why DPCs are always so keen on knowing all your telephone numbers, you mobile numbers, work numbers, etc.)

Another option for the bank, other than selling the debt to a DPC, is to hire a debt collection agency (DCA) who will then use similar tactics to the DPC in trying to collect the money.

In this case, instead of selling the debt outright, they retain the debt and pass a percentage of the sum thus recovered by the DCA to that agency.

You should note that, in cases where the debtor account is sold outright, you should by law receive a letter called a Letter of Assignment telling you this and giving you all the relevant details; some don’t bother to do this, though, it seems.

The effect on the hapless consumer, who is presumably down on his or her luck in order to be in this situation in the first place, is much the same whether a DCA or a DPC is employed.

A prolonged period of misery will ensue: phone calls at all hours of the day and night, threatening letters, threats to “send the boys round” and people knocking at the door.

And this is after the bank has lost none of its own money.

References

1. StepChange Personal Debt Statistics in Scotland 2022