What is an Event of Default?

An event of default is the occurrence of some type of event that makes it possible for the lender to initiate a demand for the immediate repayment of a loan. Typically, this type of event takes place when a debtor has failed to meet his or her obligations in terms of making the scheduled payments on the debt, and is not responsive to attempts by the lender to work with the debtor to resolve the situation. Sometimes known as accelerating the loan, the event of default makes it possible to initiate whatever actions are necessary to protect the interests of the lender and collect as much of the outstanding debt as possible.

With an event of default, the lender may attempt to make use of provisions within the loan contract to acquire control of any assets pledged as collateral on the loan. Typically, this involves a legal process that requires cooperation from the local courts. Once the collateral is in the possession of the lender, he or she is free to sell the asset in order to settle the outstanding debt. In the event that the sale price for the asset fails to yield enough to cover the entire debt, the debtor is usually responsible for settling the remainder, either in a lump sum payment or by arranging to make a series of payments to the lender via the court.

Credit card providers also make use of the event of default to protect their interests. Should a debtor fail to make at least the minimum payments on the debt each month, the account may be closed to further purchases, effectively limiting the amount of risk to the card provider. Should the debtor simply cease to make payments altogether and make no attempt to work with the provider, the balance is declared in default and may be turned over to a collection agency. As a result, the credit rating for the debtor is damaged, making it difficult to obtain loans and other forms of credit from other lenders.

There are two forms of the event of default. One is known as an actual event, in which the debtor has actually missed making payments on time or has stopped making payments altogether. A second form is known as a prospective event. Here, the debtor is current on the obligation, but there is strong evidence that he or she will not be able to make payments on time in the future.

For the most part, lenders tend to exhaust all other avenues to settle an account in arrears before resorting to the declaration of an event of default. Many will work with debtors who have recently undergone a job loss or been out of work due to health issues, sometimes accepting lower payments until the debtor is able to return to work and begin generating income once again. Some will offer to settle with debtors for less than the current amount due, making it possible to discharge the debt with minimal damage to the credit rating. As a general rule, debtors should be proactive and work with creditors to avoid an event of default and pay off the account as soon as possible under the particular circumstances.