Default

Definition

Default occurs when a borrower fails to meet the legal obligations or conditions of a loan, such as making scheduled payments. It can lead to severe financial consequences including increased interest rates and damaged credit ratings.

5 Must Know Facts For Your Next Test

1. Default can trigger the acceleration clause, requiring immediate repayment of the entire loan balance.
2. Bondholders may initiate legal action or take possession of collateral in case of default.
3. Default risk is assessed by credit rating agencies which provide ratings that influence the interest rates on bonds.
4. Companies often set aside a reserve for potential defaults to manage their financial stability.
5. Defaulting on long-term liabilities can lead to bankruptcy proceedings for a business.

Review Questions

Related terms

Acceleration Clause: A contract provision that allows lenders to demand full repayment if certain conditions are not met.

Credit Rating: An evaluation of the credit risk of a prospective debtor, predicting their ability to pay back the debt.

Collateral:

An asset pledged by a borrower to secure a loan and subject to seizure upon default.