I think we’d all agree that the past few years have been tough on tens of millions active credit consumers. Foreclosures continue to be a huge problem, we’re now in $800 billion of credit card debt, and our student loan debt just crossed the $1 trillion mark. This means it’s likely that loan defaults will increase over the next year.
I’m writing this for the consumers who find themselves in one of those difficult places where you have to decide which bills you’re going to pay each month. You can’t afford to pay all of them, but you can afford to pay some of them.
Now, who’s getting your money? Before you answer the question there are a variety of things to consider.
Which default is the worst for your credit reports and credit scores? Which default is most likely to end getting you sued? Which default can cause an interruption of your housing and transportation? And which default is going to cost you the most money?
In order to keep this information digestible, I’ve decided to split it into two parts. Today, in Part 1, we’ll explore the impact of loan defaults on your credit reports and credit scores and how defaulting can potentially expose you to litigation. What you’re going to realize is that there are pros and cons to defaulting on different types of loans.
Credit Reports and Credit Scores
You’re probably thinking, “Dude, I can’t afford to pay all of my bills. I don’t care about what’s going to happen to my credit.” Fair enough. But, while I’ve got your attention…
When you start missing payments and delinquencies start to show up on your credit report there is no hierarchy of “which one is worse?” A late payment is a late payment is a late payment, regardless of what loan or account it’s on. So a 30, 60, or 90-day delinquency on a credit card is just as bad as doing the same on a mortgage loan.
Having said that, missing payments on your mortgage will eventually hurt your scores more than missing payments on your credit card. Why?
The answer is simple: you’ll accrue a much larger delinquent balance on a mortgage than you will on a credit card. When you miss a credit card payment, the only thing that’s past due is the minimum payment. When you miss a mortgage loan payment, the repercussions could cost you thousands of dollars. And when it comes to calculating your FICO scores, there’s a component that measures past due balances.
Bottom Line: For your credit score health it’s best to miss credit card payments over mortgage or auto loan payments only because the past due balance is likely to be lower.
You should be very concerned with the prospect of being sued if you default on any of your credit obligations. You can’t ignore the guy who knocks at your door and serves you with the complaint. Well, you can, but you’ll lose by default and then you’ll be subject to a default judgment. If you do choose to fight the lender, whom you actually do owe a ton of money, you’ll be paying a lawyer to do it. That’s not a cheap date.
While any loan default can lead to you being sued, it seems to be much more common if you default on credit card debt. Normally, it takes 6 months for a credit card issuer to “charge off” delinquent credit card accounts and then they’ll likely sell them to a debt buyer. Debt buyers are notorious for suing debtors for defaulted credit cards.
If you find yourself in this situation it’s not a bad idea to make a settlement offer to the credit card issuer before your debt gets shipped off to the collection agency. They’ll make more from a settlement than they’ll make selling the debt for pennies on the dollar.
If your debt does make it to a collection agency, offering a settlement is still a viable offer and you can do this on your own. You don’t have to hire a 3rd party debt settlement company to make settlement offers on your behalf (and charge large fees at the same time).
Bottom Line: To reduce the possibility of being on the wrong side of a collection lawsuit, make sure you pay your credit cards on time and preferably off, as soon as possible.
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.