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.

More recently, in 2015, Greece defaulted on a payment to the International Monetary Fund. This wasn’t the first time the country had defaulted on a payment. In fact, in 2012, they defaulted twice.

Puerto Rico also defaulted in 2015, on a $58 million bond payment, although it had made a payment on the interest of about $628,000. After Hurricane Maria hit the island late 2017, the country’s debt of more than $100 billion has become an even bigger concern. Some suggestions for dealing with the debt have included President Trump’s idea to just wipe it out completely.

Other countries that have defaulted include Sudan, Somalia, Belize, Zimbabwe and Argentina.

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. Default can also lead to garnishment of wages and other penalties. 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.

For countries that default, the consequences can be much more serious. Similar to when consumers default, borrowing money can become much more difficult. However, for countries, this means not being able to run the country or even function. This could mean there is no money to pay policemen or even people in the military. On the other hand, a default could lead to a country devaluing its currency to pay its debt, resulting in cheaper products for export. In the end, this can help get the economy back on track.

RELATED TERMS
  1. Credit Default Contract

    Credit default contracts are products that shift risks between ...
  2. Default Risk

    Default risk is the event in which companies or individuals will ...
  3. Strategic Default

    Strategic default is a deliberate default by a borrower, as a ...
  4. Sovereign Default

    A failure on the repayment of a county's government debts. Countries ...
  5. Default Rate

    The default rate is most commonly referred to as the percentage ...
  6. Temporary Default

    Temporary default occurs when a debt issuer fails to meet loan ...
Related Articles
  1. 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.
  2. Insights

    The History Of Greek Sovereign Debt Defaults

    This isn't the first time Greece has been in financial trouble. Here's a brief history of the country's money woes.
  3. 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.
  4. Insights

    Will Argentina Default Again?

    Does a Manhattan judge's recent ruling putting Argentina on the hook for $6.1 billion in payments for its sovereign bonds increase chances of another default by South America's third-largest ...
  5. Investing

    5 Ways To Avoid Foreclosure

    If you go into default on your mortgage payments, don't worry, there are still ways to save your home.
  6. Investing

    Commercial Real Estate's $90B Debt Crunch

    Defaults on commercial real estate debt could skyrocket in 2017.
  7. Trading

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  8. Personal Finance

    What Increasing Consumer Debt and Rising Interest Rates Mean for You

    Don't be confused by the latest economic news. Learn how increasing consumer debt and rising interest rates might affect you.
  9. Investing

    The Risks Of Sovereign Bonds

    Sovereign debt can play an important role in providing international diversification to individual investors.
  10. Investing

    The History of Sovereign Debt Relief

    Europe has recently been plagued by sovereign debt crises, sparking bailouts and debt relief measures.
RELATED FAQS
  1. Difference 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. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center