What Is Default? Meaning in Finance

What is default

A default is when a borrower fails to pay interest or principal on a debt as the loan or bond contract requires.

The borrower can be a person, a company, a bank or a government. When a government fails to pay its own debt, it is called a sovereign default.

A company issues a bond. The contract says it must pay a coupon on fixed dates and repay the face value at maturity.

A coupon date arrives and the company does not pay.
The contract allows a short grace period. The company still does not pay.
When the grace period ends, the bond is in default.
The bond's market price usually falls well below face value. Bondholders may later recover only part of what they are owed, through a restructuring or a court process.

Missing the payment on the due date is not always a default straight away. What counts is what the contract says.

Payment default. The borrower misses a scheduled payment of interest or principal and the grace period runs out.
Technical default. The borrower keeps paying but breaks another term in the contract, called a covenant, such as a limit on borrowing. Lenders may then gain the right to demand early repayment.
Cross-default. A clause that treats a default on one debt as a default on other debts of the same borrower.
Distressed exchange. The borrower offers creditors new debt worth less than the old debt, and creditors accept to avoid something worse. Rating agencies often treat this as a default, even though no payment was missed.
Selective or restricted default. A rating label used when a borrower defaults on some obligations but keeps paying others.
Credit event. The formal trigger in a credit default swap (CDS), a contract that pays out if a borrower defaults. What counts as a credit event depends on the contract and on official determinations, not on news headlines.
Local-currency vs foreign-currency debt. A government can usually pay debt in its own currency more easily than debt in foreign currency, such as Eurobonds. For this reason, sovereign default risk is mostly discussed in terms of foreign-currency obligations.

News. Headlines about "Pakistan default risk" or other countries' sovereign default usually refer to the government's ability to meet foreign-currency debt payments. These stories often mention reserves, the debt-to-GDP ratio, the fiscal deficit and talks with lenders.
Rating reports. Agencies rate how likely a borrower is to default. Their reports use labels such as "D" or "SD" for default and selective default.
Bond markets. Rising default risk usually shows up as a wider credit spread and higher CDS prices.
Trading. Default fears can move currencies, bond-linked instruments and stock indices sharply, and they often lead to a flight to quality. Leveraged CFD and forex trading around this kind of news can lose money fast. See risk management.
Counterparty risk. Default also describes a broker, bank or other counterparty that cannot meet its obligations. For how to check a provider's status, see Regulation and Safety.

In software, "default" also means a preset setting. That meaning is unrelated to debt.

A borrower does not pay a debt on the terms agreed in the contract.

A government fails to pay its own debt, or restructures it on terms worse for creditors.

No. Many contracts allow a grace period. A formal default usually starts only when that period ends without payment.

It often does. Rating agencies usually treat a distressed exchange as a default, even if no payment date was missed.

Through wider credit spreads, higher CDS prices, lower bond prices and rating downgrades.