What Is a Hardship Default?
A hardship default occurs when a borrower fails to make payments on their debt due to a severe financial setback, such as a long-term job loss or a medical disability. A borrower becomes “delinquent” when they fall behind on their payments. A borrower who doesn't make payments for an extended period will be deemed "in default." Many lenders will assist borrowers to get back on track after a hardship default.
Key Takeaways
- What qualifies as a hardship default depends on lender rules and debt repayment policies.
- Defaulting on debts can damage credit scores, making it difficult to borrow money or qualify for the lowest interest rates.
- Credit card and loan hardship programs can help borrowers avoid defaulting on debts and make payments manageable.
- Bankruptcy should only be considered a last-resort option for managing debt.
Understanding Hardship Defaults
Financial hardship can make paying debts and everyday expenses impossible for those without enough income or savings to cover their bills. Financial difficulties can be triggered by a variety of circ*mstances, including:
- Illness
- Injury or disability
- Job loss or extended layoff
- Unexpected expenses
- Death of a family's primary breadwinner
Default can happen when debtors miss payments or stop making payments altogether. The timing for when a default occurs differs based on the type of debt.For federal student loans, a default is recorded when the debtor is 270 or more days behind on payments. For credit cards, default typically occurs at the 180-day mark, at which point the card issuer will close the account and sell the debt to a collection agency.
Default and delinquency aren't the same. Delinquency may mean sending a payment a day late, while a default involves one or more missed payments, raising the likelihood that the debt will never be repaid.
Consequences of a Hardship Default
Lenders have processes in place for handling defaults. The creditor will initiate debt collection actions directly with the account holder. If their initial efforts are unsuccessful, they may turn the account over to a debt collection agency and write off the debt on their books as a loss. The strategies escalate over time and include:
- Sending letters requesting payment
- Phone calls or texts for payment
- Lawsuits in small claims court
- Garnishment of wages or bank accounts if a lawsuit is successful
There are rules debt collectors must follow under federal consumer protection law. For example, they can't call before 8 a.m. or after 9 p.m. without permission, and they can't call more than seven times in a week. Borrowers who feel they have been unfairly treated or had their rights violated by a debt collector can file a complaint with the Consumer Financial Protection Bureau.
Defaulted debts can be reported to any or all of the three major credit bureaus. With FICO, the most widely used credit score, payment history accounts for 35% of your score. Missed or late payments, defaults, and collection accounts all cause a score to drop and affect future borrowing.
For a borrower who defaults on a federal student loan, the federal government may get its money back by deducting it from the individual's tax refund or garnishing their wages.
How to Avoid a Hardship Default
Credit Card Hardship Programs
Credit card hardship programs are designed to help borrowers avoid default by reducing or pausing credit card payments, lowering APR, and waiving fees, such as late penalties.
Many credit card issuers offer these programs, though qualification is not automatic and is determined on a case-by-case basis. Borrowers who do not qualify may consider contacting a debt relief company to help negotiate a lower rate and reduce their outstanding debt with the credit card company.
Student Loan Forbearance and Deferment
Student loan forbearance and deferment programs can help if borrowers have federal student loans and can't make the payments. Both allow individuals to pause payments temporarily and may adjust how interest is capitalized on the loans.
The office of Federal Student Aid administers programs like the Saving on a Valuable Education (SAVE) plan that allows borrowers to reduce their monthly payments to 10% of their discretionary income, eliminates the capitalization of unpaid interest for borrowers who keep up with their payments, and provides debt forgiveness after 20 to 25 years. Borrowers can apply for the SAVE plan and research other options at the Federal Student Aid website.
On July 18, 2024, a federal appeals court blocked the SAVE plan until two court cases centered around the IDR plan can be resolved. The Department of Education has moved borrowers enrolled in the SAVE plan into an interest-free forbearance while the litigation is ongoing. It has also outlined options for borrowers who were nearing Public Service Loan Forgiveness (PSLF)—borrowers can either "buy back" months of PSLF credit if they reach 120 months of payments while in forbearance or switch to a different IDR plan.
Additionally, those who have defaulted on their student loans have a limited period of time to get out of default with minimal consequences. The Fresh Start program offers borrowers the opportunity to start paying down defaulted loans while removing a record of the default from their credit report. Entering the Fresh Start program also allows you to access federal student loan funds again. The program is open until Sept. 30, 2024.
Mortgage Modification and Forbearance
Mortgage holders who can't make home loan payments have options for avoiding default and eventual foreclosure. A loan modification allows borrowers to rework the terms of their loan to make their payments better fit their budget.
Mortgage forbearance is similar to student loan forbearance, which pauses mortgage payments temporarily. Whether interest and fees accrue on the loan during this time depends on the terms of the lender's forbearance program. If forbearance or a loan modification isn't an option, borrowers can try refinancing their mortgage to a lower rate.
Using hardship deferment or forbearance programs may be reported to the credit bureaus and may hurt a borrower's credit score.
What Qualifies As a Financial Hardship?
A financial hardship is a situation recognized by a lender as contributing to the delinquency or default on a debt. Most lenders have criteria for these hardships, such as a sudden job loss or other unforeseen event that reduces a debtor's ability to make payments.
What Is a Hardship Loan?
A hardship loan is a loan approved for those experiencing a financial crisis, such as medical bills or emergency car repairs. Eligible small businesses may apply for a hardship accommodation plan (HAP) through the Small Business Administration.
What Does Filing for Hardship Mean to Taxes?
The Internal Revenue Service (IRS) recognizes a hardship concerning paying taxes when an individual can demonstrate it. When appropriate, the IRS may accept a lower amount than is due for taxes in what is known as an offer in compromise.
The Bottom Line
Neglecting debt is one of the worst things borrowers can do when experiencing financial hardship. Consumers should remain in contact with their creditors as well as seek assistance for making payments and avoiding default.
