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By Konstantin Vasilev Member of the Board of Directors of Cbonds, Ph.D. in Economics
Updated July 1, 2023

What Is a Default?

Default refers to the failure of an individual, business, or country to fulfill their required interest or principal repayments on a debt, whether it be a loan or a security. This failure can occur with various types of loans, such as federal student loans, auto loans, personal loans, mortgage loans, or credit card debt. When defaulting on a loan, the borrower fails to make timely payments, resulting in serious consequences.

Default risk is an essential consideration for creditors, including loan holders, loan servicers, and debt collection agencies. Creditors may report default incidents to credit bureaus, affecting the borrower’s credit score and credit reports. In the case of federal student loans, defaulting can lead to wage garnishment and the loss of future federal student aid eligibility.

Defaulted loans can be subject to collection fees, court costs, and potential legal actions by debt collectors. Creditors may seek to recover the unpaid debt by garnishing wages or seizing personal property, depending on the loan type. The consequences of default can remain on credit reports for up to seven years, negatively impacting the borrower’s ability to borrow money and obtain consumer credit in the future.


Understanding Defaults

Default can occur in various situations involving different types of debt. For instance, secured debt, like a mortgage loan backed by a house or a business loan supported by a company’s assets, is susceptible to default. If a borrower fails to make payments on time, the loan can go into default, putting the collateral at risk. In the case of a mortgage loan, the house used as collateral could be in jeopardy, while for a business loan, the assets securing it may be at stake. Similarly, if a company is unable to meet the required coupon payments on its bonds, it would be considered in default.

Unsecured debt, such as credit card balances, is also prone to defaults. When a borrower fails to fulfill their obligations, their credit rating is negatively affected, potentially limiting their ability to borrow money in the future. It is important to note that defaulting on any type of debt can have significant repercussions and impact the borrower’s financial standing.

Who Is a Defaulter?

A borrower is classified as a defaulter when they fail to make any interest or principal repayments for a duration of 90 days. At this point, the loan is categorized as a non-performing asset (NPA), which triggers certain actions by banks or financial institutions. In order to account for potential losses, banks are required to allocate additional funds as provisions.

When a loan is marked as an NPA, it signifies that the borrower is no longer meeting their repayment obligations, and the loan is considered to be at risk. To mitigate the impact of potential losses, banks set aside provisions, which are funds allocated specifically to cover any anticipated losses associated with the defaulted loan. This practice helps banks maintain financial stability and protect their overall balance sheets.

The term bank defaulter refers to individuals, businesses, or entities that have failed to repay their loans or fulfill their financial obligations to a bank or financial institution. Bank defaulters can include borrowers from various sectors, such as retail customers, small and medium-sized enterprises (SMEs), large corporations, or even government entities. These defaulters may have borrowed funds for purposes such as personal loans, mortgages, business loans, credit card debts, or any other type of credit facility offered by banks.

Defaulting on Secured Debt vs. Unsecured Debt

Secured Debt

If a borrower defaults on a mortgage, the bank reserves the right to initiate foreclosure proceedings on the property that serves as collateral for the mortgage. Similarly, in the case of an auto loan default, the lender has the authority to repossess the vehicle. These instances illustrate the concept of secured loans, where the lender holds a legal claim to a specific asset acquired using the loan.

When corporations find themselves in default on secured debt, they may opt to file for bankruptcy protection as a strategic measure to prevent the forfeiture of assets. By seeking bankruptcy protection, corporations gain a period during which they can negotiate with creditors to reach a settlement agreement. This allows them to restructure their financial obligations and potentially mitigate the consequences of default.

Unsecured Debt

Default can also take place with unsecured debt, including medical bills and credit card balances. Unlike secured debt, unsecured debt lacks collateral, but the lender still maintains a legal claim in case of default. Credit card companies typically allow a few months to pass before classifying an account as in default.

If a borrower fails to make any payments on an outstanding balance for six months or longer, the debt may be charged off. This means the lender considers it a loss and closes the account. Subsequently, the creditor may choose to sell the charged-off debt to a collection agency, which takes on the responsibility of attempting to collect the outstanding amount from the borrower.

Sovereign Default

Sovereign default refers to the failure of a country to repay its debts. This can occur with both secured and unsecured loans. In the case of a loan default, a country is generally not legally obligated to fulfill its debt obligations, but it faces a range of associated risks and challenges.

Default on a loan can also happen with unsecured debt, such as personal loans or credit card balances. While unsecured loans lack collateral, the lender still retains a legal claim in the event of default. Credit card companies typically allow a few months before considering an account in default.

In the event of a sovereign default, the entire unpaid balance of the debt becomes a concern. The defaulting country may experience economic repercussions, including a recession or currency devaluation. Additionally, the default may lead to the exclusion of the country from debt markets for an extended period.

Sovereign default can stem from various factors, including political unrest, economic mismanagement, or a banking crisis. For instance, Greece defaulted on a $1.73 billion payment to the International Monetary Fund (IMF) in 2015 before negotiating additional debt relief from the European Union.

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Defaulting on a Futures Contract

Defaulting on a futures contract occurs when one party fails to fulfill the obligations set forth by the agreement. Defaulting here usually involves the failure to settle the contract by the required date.

A futures contract is a legal agreement for a future transaction involving a particular commodity or asset. One party to the contract agrees to buy at a specific date and price, while the other party agrees to sell at the contract-specified milestones. If one party defaults, they could face collections actions and lawsuits, among other things.


In 2015, Puerto Rico faced a default when it failed to make a sufficient loan payment, only contributing $628,000 towards a $58 million bond payment. This event further complicated the island’s economic and debt crisis, which was already strained due to the devastating impact of Hurricane Maria in 2017.

In 2019, Puerto Rico announced its intentions to reduce its overall debt from $129 billion to approximately $86 billion, marking the largest bankruptcy in U.S. history. This process was made possible by enacting the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) in 2016, a passed law by Congress. PROMESA also established a financial oversight board tasked with supervising the territory’s public finances, including managing loan payments and debt obligations.

Taking steps towards recovery, in early 2022, a U.S. judge approved a restructuring plan as part of the bankruptcy process. This plan aimed to reduce Puerto Rico’s public debt from $70 billion to $37 billion, resulting in a significant alleviation of financial burdens.

Throughout this challenging period, various terms related to loan defaults, debt collection agencies, loan payments, and financial hardships emerged. However, Puerto Rico’s efforts to address its debt crisis included the implementation of alternative repayment plans, loan consolidation, and negotiations with loan holders. These actions aimed to avoid defaulting on various types of loans, including personal loans, student loans, and credit cards, which could negatively impact credit scores and lead to garnished wages. Payment history missed payments, and late payments were closely monitored as part of the repayment plan, while future loans were subject to careful consideration given the territory’s financial circumstances.


  • What happens if I default on my student loan?

  • How long does a loan stay in default?

  • How long will a default stay on my credit report?

  • What happens when a bank defaults?

  • How do banks deal with defaulters?

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