In finance, default is what occurs when a party is unwilling or unable to pay their debt obligations. This can occur with all debt obligations including bonds, debentures, mortgages, loans, and promissory notes. Default can also occur with sovereign bonds, that is, governments can default on their payments to creditors.
In corporate finance, a default is typically a prelude to bankruptcy.
With most mortgages and loans the total amount owing becomes immediately payable on the first instance of a default of payment.
Advantages
- Debt disappears, to the extent that one can escape one's creditors or any legal process which they might try to utilize. Obviously, sovereigns have a better chance of getting away with converting debt into a forced gift (which hapless creditors might call theft).
- After default, one can start over with a clean slate.
Disadvantages
- Interest rates for a debtor often rise if lenders become aware that the debtor has a realistic chance of defaulting in the near future.
- There are very few sane or well-informed people who will lend money to a party who has defaulted in the past. Even if not completely shut off from credit, the defaulted party will have to pay very high interest rates to cover the risk that they will default again.
- Because credit is now so expensive, the former debtor must be careful to always operate in such a way so that current accounts receivables will always cover current accounts payable.
See also
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