Credit

Part 2: The Worst Loan You Can Default On Is…..

late bills

Last week we explored the impact defaulting on loans has on your credit reports and credit scores, and how it can leave you on the wrong end of a collection lawsuit. You can read that article here.

Today I’m closing out this 2-part series by exploring the impact of letting your auto loan and your home go into default.

Transportation

Unless you live in a city where rapid transit is a viable transportation option or you can ride your bike to work, you’re probably going to need a car. And no, public transportation isn’t really a realistic alternative in most large and expansive metropolitan areas. You’re going to need your car to get to work, chauffeur the kids, do your shopping, etc.

If you stopped making your car payments today, your car would be gone in 60-90 days. That’s a much faster response from a jilted lender than you would see with any other type of loan. It normally takes 6 months for a credit card issuer to charge off your balance. And, you’ll see below that not paying your mortgage lender doesn’t lead to immediate homelessness.

Bottom Line: In my opinion, defaulting on your auto loan is going to leave you with more problems than any other loan default. You can live without a credit card, but you can’t live without transportation to earn a living and take care of your family.

Housing

I know what some of you are probably asking, “Why wouldn’t you pay your mortgage first? You need a place to live, right?” You are absolutely correct. You do need a place to live. The good news is that even if you stop paying your mortgage today, you’ll have a place to live for probably the next 12-24 months.

It’s taking forever for lenders to begin foreclosure proceedings and even if/when foreclosure proceedings do start, it doesn’t mean you’re getting kicked out of your house. That’s the next step.

I’m sure we’ve all heard the stories of homeowners refusing to pay their mortgages and living rent-free for years before the lender has them evicted. In fact, there are even examples where the mortgage lender or the investor who has purchased the home out of default actually pays the former owner to leave.

I’m not suggesting this is the right thing to do; I’m just pointing out the realities in the mortgage default world right now.

Bottom Line: Defaulting on your mortgage is going to eventually cost you your home. But, that’s going to take some time and you may be able to use the extra money from the mortgage payment you’re not making to pay down/off other more expensive credit card debt.

Financial Burden

Financially, any default is going to sting, but the pain is variable across loan types.

For example, if you default on a car loan, the lender is going to pay to repossess the car and then probably liquidate it at auction. You’ll be held liable for any deficiency that remains after the car is sold. That could be as little as a few thousand dollars, unless you borrowed a ton of money to buy a quickly depreciating model.

Defaulting on a mortgage loan is going to lead to the same type of financial burden, just a much larger dollar amount. Once the house has been liquidated, likely for much less than you owe on the loan, you may or may not be liable for the deficiency balance. It’s not that cut and dry though, and you’ll want to speak with a lawyer and even a tax advisor about it.

Defaulting on a credit card is a different animal. There is nothing to repossess, which means there’s nothing to liquidate and apply toward your balance. You owe it all, plus interest.

Even when you default, the credit card issuer can still charge you interest and apply late fees. When they finally sell the debt to a collection agency, they can also charge interest. And, if they are successful getting a judgment against you, then yes, more interest can accrue, too.

John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a contributor for the National Foundation for Credit Counseling.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. Follow John on Twitter.