The default rate is a crucial metric that represents the percentage of all outstanding loans a lender decides to write off as unpaid after continuous missed payments. This rate can also reflect the higher interest rate imposed on borrowers who miss regular payments on their loans.
Key Takeaways
- The default rate is the share of loans written off by lenders after prolonged non-payment.
- Typical loans are declared in default after being 270 days late in payments.
- Default rates help economists assess the health of the economy.
Understanding the Default Rate
Default rates are invaluable to lenders for measuring exposure to risk. A high default rate may prompt a bank to review its lending procedures to mitigate credit risk. Economists also use default rates to gauge the economy’s overall health.
Several indexes, notably produced by Standard & Poor’s (S&P) and Experian, help keep track of various consumer loans’ default rates over time. These indexes cover a range of loan types, such as home mortgages, car loans, and credit cards. The most comprehensive index is the S&P/Experian Consumer Credit Default Composite Index, which includes data from first and second mortgages, auto loans, and bank credit cards. As of January 2020, this composite index reported a default rate of 1.02%, with its highest rate in recent years being 1.12% in February 2015.
Bank credit cards often show the highest default rates, as evidenced by the S&P/Experian Bankcard Default Index, which reported a rate of 3.28% as of January 2020.
Actions around missed payments usually become serious after the second missed period, categorizing accounts as delinquent after 60 days and reporting them to credit agencies. Delinquent accounts entail higher penalties, including increased interest rates which remain on an individual’s credit report for years.
If payments continue to be missed, the loan’s status evolves from delinquent to defaulted. For products such as student loans, federal mandates specify a default period of 270 days, while other types follow state laws. Default severely harms the borrower’s credit score, complicating future credit approvals.
The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 enacted significant changes, including banning interest rate hikes for delinquencies unrelated to the card account and permitting increased default rates only if an account is 60 days overdue.
Related Terms: Interest rate, Credit Score, Delinquency, Credit Risk, Economic Health.
