In finance, “default” refers to the failure to fulfill the obligations of a loan or debt. This typically happens when a borrower is unable to make their required payments to their lender.
Default can take place in various forms, including:
- Payment default: This happens when a borrower fails to pay a loan installment on time. It could be a one-time event or could happen multiple times.
- Technical default: This happens when a borrower fails to meet the other terms and conditions of the loan agreement, which may not necessarily be payment-related. For example, many loans require borrowers to maintain certain financial ratios or fulfill certain obligations. If the borrower fails to do this, they may be in technical default.
- Strategic default: This happens when a borrower voluntarily decides to stop making payments, even though they may actually have the ability to pay. This usually happens in situations where the value of the asset (like a home) financed by the loan falls below the outstanding loan amount, and the borrower decides it’s economically better for them to just walk away.
When a borrower defaults on a loan, the lender may take legal action to recover the funds, which could involve seizing the borrower’s assets (collateral), if any were used to secure the loan. The borrower’s credit score would also typically be negatively affected, making it harder for them to borrow money in the future.
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