Loading the player...

What is 'Default'

Default is the failure to pay interest or principal on a loan or security when due. Default occurs when a debtor is unable to meet the legal obligation of debt repayment, and it also refers to cases in which one party fails to perform on a futures contract as required by an exchange.

BREAKING DOWN 'Default'

If an individual fails to make his monthly mortgage payments, he defaults on the loan. Similarly, if a business issues bonds and it is unable to make coupon payments to its bondholders, the business is in default on its bonds. When deciding whether to issue a loan or invest in a debt security, lenders and investors must carefully consider the chance of default and must manage its risk.

How Lenders and Investors Deal With Default

When an individual, a business or even a nation defaults on a debt obligation, the lender or investor has some recourse to reclaim the funds, but it varies based on the type of security involved. For example, in cases of default, a mortgage lender can reclaim the home securing the mortgage. In contrast, a credit card issuer may simply have to write off the debt as bad.

If a business goes into bankruptcy, it effectively defaults on all its loans and its bonds. Creditors with loans secured by the business's assets, such as buildings, inventory or vehicles, may reclaim those assets in lieu of repayment. If there are any funds left over, the company's bondholders receive a stake in them, and shareholders are next in line.

Defaulting on a Futures Contract

Defaulting on a futures contract occurs when one party does not fulfill the obligations set forth by the agreement, and it usually involves failure to settle the contract by the required date. A person in the short position defaults if he fails to deliver the goods at the end of the contract, while the long position defaults when payment is not provided by the settlement date.

Sovereign Default

Also called national default, sovereign default occurs when a country cannot repay its debts. When a country defaults, its economy shrinks, potentially throwing the country into a depression and devaluing its currency. Sovereign default, like other types of default, happens for a variety of reasons. For example, Jamaica defaulted on $7.9 billion in 2010, due to government overspending, high debt loads and drops in tourism, the country's key industry. In contrast, when Ecuador went into default in 2008 on $3.2 billion, it did so simply because its government did not want to repay its debts.

Consequences of Default

When a borrower defaults on a loan, it creates a negative mark on his credit report, reducing the chances of obtaining credit in the future. Similarly, when bond issuers default on bonds or exhibit other signs of poor credit management, ratings agencies lower their credit ratings. Credit ratings agencies such as Standard and Poor's issue credit ratings for business, municipalities, countries and other entities.

RELATED TERMS
  1. Credit Default Contract

    Security with a risk level and pricing based on the risk of credit ...
  2. Temporary Default

    A bond rating that suggests the issuer might not make all of ...
  3. Default Probability

    The degree of likelihood that the borrower of a loan or debt ...
  4. Default Risk

    The event in which companies or individuals will be unable to ...
  5. Default Premium

    The additional amount a borrower must pay to compensate the lender ...
  6. Sovereign Default

    A failure on the repayment of a county's government debts. Countries ...
Related Articles
  1. Taxes

    Understanding Default Risk

    Default risk is the chance that companies or individuals will be unable to pay their debts.
  2. Personal Finance

    What Happens in a Default?

    Borrowers are in default when they don’t honor a debt, whether their failure is intentional or not.
  3. Insights

    Why and When Do Countries Default?

    Countries can default on their debt. This happens when the government is either unable or unwilling to make good on its fiscal promises.
  4. Insights

    How Countries Deal With Debt

    For many emerging economies, issuing sovereign debt is the only way to raise funds, but things can go sour quickly.
  5. Financial Advisor

    Junk Bond

    Find out more about these bonds that have a high risk of default.
  6. Investing

    How Credit Rating Risk Affects Corporate Bonds

    Credit migration risk is a vital part of the credit risk assessment, specifically with regard to corporate bonds which underlie numerous rating changes.
  7. Financial Advisor

    Emerging Market Defaults: Beware of Second Wave

    Emerging market corporate defaults have the potential to be the biggest risk to global markets.
  8. Investing

    High-Yield Bond ETFs: 3 Reasons to Avoid Them

    Examine high-yield bond performance in 2016. Why do rising default rates, falling recovery rates and Fed rate hikes make these securities worth avoiding?
  9. Investing

    Junk Bonds’ Performance After the Financial Crisis

    How did higher-yielding bonds perform during and after the financial crisis of 2007-2009?
  10. Investing

    2 ETFs That Will Hurt From Rising Default Rates (HYG, JNK)

    Learn about two high-yield bond ETFs that could be adversely affected if the trend of increasing corporate default rates continues.
RELATED FAQS
  1. What level of default rate is typical for the credit services industry?

    Learn how default rates affect businesses in the credit services industry, and what rates are considered normal for a company ... Read Answer >>
  2. In the beginning of this year, the total par value of all CCC-rated bonds were $12 ...

    The correct answer is: d) (i) Default Loss Rate = [($1.3 billion - $625 million)/$1.3 billion] = 51.9% (ii) Dollar Default ... Read Answer >>
  3. In what types of financial situations would credit spread risk be applied instead ...

    Find out when credit risk is realized as spread risk and when it is realized as default risk, and learn why market participants ... Read Answer >>
  4. What factors are taken into account to quantify credit risk?

    Learn how probability of default, or PD; loss given default, or LGD; and exposure at default, or EAD, are used to help quantify ... Read Answer >>
  5. What special powers does the government have to collect student loans?

    Contact student loan companies before student loans default, as the government has the power to get its money. Prior to default, ... Read Answer >>
  6. What are the differences between delinquency and default?

    Find out more about loan delinquency, loan default, and the difference between a loan borrower defaulting and being delinquent ... Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center