What it is:
A default is a violation of a promise to payin agreed amounts at agreed times.
How it works/Example:
Let's assume Company XYZ has a line of
Company XYZ is having trouble with the launch of its new product and is dealing with a recall on four of its other products. dropped 75% and dried up, making it hard to make the debt payments. For a few months, Company XYZ makes late payments, and then after six months it stops making payments altogether. Bank ABC declares Company XYZ in default and demands immediate of the $5 million outstanding principal.
This of course is very hard for Company XYZ to handle, and Bank ABC begins the process of seizing the collateral that secured the debt. Without these assets (let's say they're machinery), Company XYZ cannot continue production and thus closes its doors.
In general, there are six events involved in a default (in this example, we assume the borrower has obtained a mortgage for a house from the ).
- The borrower signs a contract agreeing to repay the lender over a period of time, usually in predetermined installments.
- The borrower misses one or more payments.
- The lender sends the borrower one or more notices of delinquency.
- The borrower and the lender try to adjust the repayment schedule so that the borrower is more likely to make at least some of the payments until he or she gets back on his feet. (This process is called special forbearance or mortgage modification.)
- The borrower still misses payments.
- The lender sends the borrower a notice of default and initiates foreclosure proceedings.
Why it matters:
Defaults are serious matters, and they are far more serious than simply being overdue in a payment (though this can trigger a lender seizes and sells a borrower's when the borrower has failed to repay the lender. The is most often associated with .
Defaults do long-term damage to a person's and can hinder a company's ability to raise in the future. It is important to that foreclosure laws vary by state, and they affect the order or of these steps. It is also important to that the federal Fair Collection Practices Act affects foreclosure proceedings by stipulating the methods can use to go after bad .
Default risk is the chance that a not make the required payments or to . Many things can influence an issuer's default risk and in varying degrees. Examples include poor or falling from operations (which is often needed to make the interest and principal payments), rising interest rates (if the are floating-rate , rising interest rates increase the required interest payments), or changes in the nature of the marketplace that would adversely affect the issuer (such as a change in technology, an increase in competitors or regulatory changes). The default risk associated with foreign bonds also includes the home country's sociopolitical situation and the stability and regulatory activity of its government.