What Is the Default Rate?
Let me explain the default rate directly to you: it's the percentage of all outstanding loans that a lender writes off as unpaid after a prolonged period of missed payments. You might also hear it called the penalty rate, which refers to the higher interest rate slapped on a borrower who's missed regular payments on a loan.
Typically, an individual loan gets declared in default if the payment is 270 days late. At that point, defaulted loans are written off from the issuer's financial statements and handed over to a collection agency.
I should note that the default rate of banks' loan portfolios, along with other indicators like the unemployment rate, inflation rate, consumer confidence index, personal bankruptcy filings, and stock market returns, is often used as an overall gauge of economic health.
Key Takeaways
- The default rate is the percentage of all outstanding loans that a lender has written off after a prolonged period of missed payments.
- A loan is typically declared in default if payment is 270 days late.
- Default rates are an important statistical measure used by economists to assess the overall health of the economy.
Understanding the Default Rate
As I see it, default rates are a key statistical measure that lenders use to figure out their exposure to risk. If a bank has a high default rate in its loan portfolio, it might have to reassess its lending procedures to cut down on credit risk—that's the chance of loss from a borrower failing to repay a loan or meet obligations. Economists also use the default rate to evaluate the economy's overall health.
Standard & Poor's (S&P) and Experian team up to produce indexes that track default rate movements over time for consumer loans like home mortgages, car loans, and credit cards. These are known as the S&P/Experian Consumer Credit Default Indexes, including the Composite Index, First Mortgage Default Index, Second Mortgage Default Index, Auto Default Index, and Bankcard Default Index.
The S&P/Experian Consumer Credit Default Composite Index is the broadest one, covering first and second mortgages, auto loans, and bank credit cards. As of January 2020, it showed a default rate of 1.02%, with its peak in the prior five years at 1.12% in mid-February 2015.
Bank credit cards usually have the highest default rates, as seen in the S&P/Experian Bankcard Default Index, which was at 3.28% in January 2020.
Important Notes on Delinquency and Defaults
Here's something important: a default record sticks on your credit report for six years, even if you eventually pay the amount.
Lenders don't get too worried about missed payments until after the second one. When you miss two consecutive payments—making you 60 days late—the account becomes delinquent, and the lender reports it to credit agencies. Delinquency means you're not making payments on time or regularly as per your debt obligations.
That delinquent payment shows up as a negative on your credit rating, and the lender might hike your interest rate as a penalty.
If you keep missing payments, the lender will keep reporting the delinquencies until the loan is written off and declared in default. For federal loans like student loans, that's around 270 days; for others, state laws set the timeline.
Defaulting on any consumer debt hurts your credit score, which can make it tough or impossible to get future credit approval.
The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 set new rules for credit cards. It stops lenders from raising your interest rate due to delinquency on other debts, and they can only charge a higher default rate after your account is 60 days past due.
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