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A default rate is simply defined as the rate at which borrowers default on their loans. It is one of the most critical pieces of information, especially for lenders who may be saddled with significant losses in the event of a default. A default rate can be applied in the context of personal loans or business loans.
The default rate is especially critical when dealing with credit cards. Many times, because this is unsecured debt, an individual may be quicker to default on this type of loan than others, which could cause the loss of a home or automobile. Also, credit cards can be used to purchase nearly anything and therefore may become the main way for a person to buy goods and services once in financial difficulty. This just compounds the problem and the risk of being unable to pay back.
Investors and market analysts may also look at the default rate as a sign the economy is slowing down. When the economy slows, and businesses and individuals still have the same amount of debt, it may be harder for them to come up with the money to repay. Often this is because their disposable income also decreases. Therefore, a default rate may not only be a sign of a slowing economy, but may have the effect of slowing the economy even further.
There are are certain things companies may try to do to avoid defaults and thus keep the default rate lower. In some cases, if a debt holder may be willing to renegotiate the terms of the loan in order to avoid a default, it is a good option for both the debt holder and borrower. However, the renegotiation could be reported to the credit agencies and adversely affect the borrower's credit rating.
In business, a default rate could apply to a small business taking a loan from a bank, or may apply to corporations who default on bonds. This is especially critical when considering the health of an economy. Business defaults may indicate a serious economic problem within a nation, even more so than individual defaults.
Investors often keep a close eye on the default rate, especially when considering which financial companies and banks to invest in. However, it can also effect the overall investor mood. While is is not listed in the United States as a key economic indicator, the default rate may be one of those unofficial indicators that is watched just as closely.
@jholcomb - I'm not sure how the student loan default rate compares to other sorts of loans, but I've heard that it's high. The thing a lot of people don't realize about student loans is that they cannot be discharged through bankruptcy. So you could go completely broke and lose everything, and still have your loan hanging over your head!
I've heard that rules have been tightened a bit in the last few years, though, as part of the general credit contraction, and that such risky loans are harder to get these days. Which makes sense - if a loan is going to be so strict that you can't discharge it through bankruptcy, it seems like the lenders should have to
be extra-careful what loans they make.
I agree with you that a lot of students just don't show enough foresight. I once temped in an accounting office and had a guy on the phone tell me, "I stopped going to school, so my student loans went into default." Notice that the option of paying the money back that he had borrowed never seemed to have occurred to him!
Are student loan default rates higher than for other sorts of loans? I've always wondered this because you hear about students taking out quite sizable loans - six figures, in some cases, even just for their undergraduate education. It seems like they could not possibly pay back that much money in ten or even thirty years.
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