Default Rate

What Is the Default Rate?

The default rate is the percentage of all outstanding loans that a lender has written off as unpaid after a prolonged period of missed payments. The term default rate–also called penalty rate–may also refer to the higher interest rate imposed on a borrower who has missed regular payments on a loan.

An individual loan is typically declared in default if payment is 270 days late. Defaulted loans are typically written off from an issuer’s financial statements and transferred to a collection agency.

The default rate of banks' loan portfolios, in addition to other indicators–such as the unemployment rate, the rate of inflation, the consumer confidence index, the level of personal bankruptcy filings, and stock market returns, among others–is sometimes used as an overall indicator of economic health.

Understanding the Default Rate

Default rates are an important statistical measure used by lenders to determine their exposure to risk. If a bank is found to have a high default rate in their loan portfolio, they may be forced to reassess their lending procedures in order to reduce their credit risk–the possibility of a loss resulting from a borrower's failure to repay a loan or meet contractual obligations. The default rate is also used by economists to evaluate the overall health of the economy.

Standard & Poor's (S&P) and the credit reporting agency Experian jointly produce a number of indexes that help lenders and economists track movements over time in the level of the default rate for various types of consumer loans, including home mortgages, car loans, and consumer credit cards. Collectively, these indexes are referred to as the S&P/Experian Consumer Credit Default Indexes. Specifically, these are the names of the indexes: S&P/Experian Consumer Credit Default Composite Index; S&P/Experian First Mortgage Default Index; S&P/Experian Second Mortgage Default Index; S&P/Experian Auto Default Index; and S&P/Experian Bankcard Default Index.

The S&P/Experian Consumer Credit Default Composite Index is the most comprehensive of these indexes because it includes data on both first and second mortgages, auto loans, and bank credit cards. As of January 2020, the S&P/Experian Consumer Credit Default Composite Index reported a default rate of 1.02%. Its highest rate in the previous five years was in mid-February 2015 when it reached 1.12%.

Bank credit cards tend to have the highest default rate, which is reflected in the S&P/Experian Bankcard Default Index. The default rate on credit cards was 3.28%, as of January 2020.

A default record stays on the consumer's credit report for six years, even if the amount is eventually paid.

Lenders do not get overly concerned with missed payments until the second missed payment period is passed. When a borrower misses two consecutive loan payments (and is thus 60 days late in making payments), the account is considered delinquent and the lender reports it to the credit reporting agencies. Delinquency describes a situation wherein an individual with a contractual obligation to make payments against a debt–such as loan payments or any other kind of debt–does not make those payments on time or in a regular, timely manner.

The delinquent payment is then recorded as a black mark on the borrower's credit rating. The lender may also increase the borrower's interest rate as a penalty for late payment.

If the borrower continues to miss payments the lender will continue to report the delinquencies up until the loan is written off and declared to be in default. For federally-funded loans such as student loans, the default timeframe is approximately 270 days. The timetable for all other loan types is established by state laws.

Default on any kind of consumer debt damages the borrower’s credit score, which may make it difficult or impossible to get credit approval in the future.

The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 created new rules for the credit card market. Notably, the Act prevents lenders from raising a card holder's interest rate because a borrower is delinquent on any other outstanding debt. In fact, a lender can only begin charging a higher default rate of interest when an account is 60 days past due.