What Happens If You Default on a Private Loan?

Key takeaways

• The most common default is failing to exit at the end of a short term.
• Default interest and enforcement costs are contractual - read them before you sign.
• A registered mortgagee can ultimately exercise a power of sale.
• Talk to the lender early; an extension arranged in advance is far cheaper than a default.

What counts as a default?

Your loan contract defines it, and the definition is usually broader than missing a payment. On a short-term private facility the most common default is simply reaching the end of the term without repaying, because the sale or refinance that was meant to repay it has not happened.

Contracts commonly also treat as default: breaching a covenant, letting insurance lapse, allowing another encumbrance over the security, providing misleading information, or the security falling in value beyond an agreed threshold.

This is why the default clauses deserve as much attention as the interest rate. They decide what happens on the worst day of the facility, and they are read closely by exactly nobody on the best day.

What the lender can do

Default interest applies from the default date, at a rate set in the contract and usually well above the ordinary rate, and it commonly applies to the whole balance rather than the overdue portion. Enforcement and legal costs are added to what you owe.

Where the lender holds a registered mortgage, it can ultimately exercise a power of sale over the property after following the required notice process. Where the security is a caveat, the lender's position is weaker but the caveat still blocks you from selling or refinancing without dealing with them.

A guarantor - including a company director who has given a personal guarantee - can be pursued for the shortfall if the security does not cover the debt. That is the point at which company borrowing becomes a personal problem, and it is why guarantees deserve advice before signature rather than after default.

What to do if you are heading for default

Act before the term expires, not after. A lender approached six weeks out with evidence of a delayed settlement is in a completely different frame of mind from one contacted after the due date has passed.

1. Tell the lender early, with evidence of what has changed and when the exit will now occur.
2. Ask for an extension in writing and get the cost of it confirmed before you agree.
3. Look at refinancing - another lender may take out the facility, and that is easier before a default is recorded.
4. Get your own legal advice immediately, particularly if a guarantee or your home is involved.
5. Consider selling on your own terms, which almost always realises more than an enforced sale.

If the lending is regulated consumer credit, you may have a statutory right to request a hardship variation. On business-purpose lending you generally do not - but a commercial lender still usually prefers a workable plan to an enforcement process, because enforcement is slow and expensive for them too.

Frequently asked questions

Can a private lender take my property?

A lender holding a registered mortgage can ultimately exercise a power of sale after following the notice process in the contract and the relevant legislation. A caveat alone does not give a power of sale, but it blocks you selling or refinancing without addressing the debt.

What is default interest?

A higher rate applied from the date of default, set by your contract and commonly applied to the entire balance rather than just the arrears. Enforcement and legal costs are usually added on top.

Do hardship protections apply to a private loan?

Statutory hardship provisions apply to regulated consumer credit. Lending wholly or predominantly for business purposes generally falls outside that regime, so what you can ask for depends on your contract and the lender's willingness.

Will a private loan default show on my credit file?

It can, where the lender participates in credit reporting and the applicable rules are met. Beyond reporting, a default and any judgment become part of the history that future lenders assess.

Related reading

• Are Private Lenders Safe and Regulated in Australia?
• Second Mortgages: Consent, Priority and Bad Credit
• Caveat Loan vs Second Mortgage: Which Do You Need?

Sources

• Problems with debt — Moneysmart, ASIC
• National Credit Code — Australian Government