What is Default Rate
The default rate is most commonly referred to as the percentage of loans that have been charged off after a prolonged period of missed payments. Defaulted loans are typically written off from an issuer’s financial statements and transferred to a collection agency. In some cases a default rate may also be a higher interest rate charged to a borrower after a specified number of missed payments occur.
BREAKING DOWN Default Rate
Default rates are an important statistical measure used by lenders to determine their risk exposure and economists to evaluate the health of the overall economy. S&P and credit reporting agency Experian have partnered to provide numerous indexes that help lenders and economists track the level of defaults over time. Indexes from S&P/Experian include: 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 the S&P/Experian Bankcard Default Index. The S&P/Experian Consumer Credit Default Composite Index is the most comprehensive in the series with default data encompassing first and second mortgages, auto loans and bankcards. As of December 2017 the S&P/Experian Consumer Credit Default Composite Index reported a default rate of 0.91%. Of all the components in the series, bankcards had the highest default rate at 3.44%.
Process to Default
When a borrower misses two consecutive loan payments their late payment records will be submitted to credit reporting agencies for marks on the trade line credit account. Two consecutive missed payments is considered 60 days delinquent. If a borrower continues to miss payments the credit issuer will continue to report delinquencies up to a specified timeframe when it will be written off and considered in default. For federal loans the default timeframe is 270 days for other types of credit the timeframe is mandated by state laws. Default on a credit product will substantially affect a borrower’s credit score and the potential for future credit approvals. (See also: What are the differences between delinquency and default?)
Default Rate Penalties
When a borrower fails to make a loan payment there are a number of negative repercussions. Typically lenders are not concerned with missed payments until the second missed payment occurs. Once the second missed payment occurs lenders will begin reporting missed payments to credit reporting agencies and the borrower may have to pay a higher penalty rate of interest. The terms for increased penalty rates of interest are detailed in a borrower’s lending agreement. This rate may be called a default rate of interest or a delinquent rate of interest. Credit issuers have the option to include this penalty in their lending agreements and may establish their own parameters for when it is instituted and repealed.
CARD Act of 2009
The Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009 created new legislations for the credit card market. Among other changes, this legislation halted lenders from instituting universal default rates which cause an interest rate increase when a borrower has delinquencies on any of their outstanding debt. According to the CARD Act of 2009 lenders can only begin charging a higher default rate of interest when an account has become 60 days past due. They cannot base the rate increase on other account activity but they are able to raise rates for a borrower who has more than one card with the company if delinquent activity occurs.