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What Happens When You Default on an Unsecured Loan?

If you have an unsecured loan – like a personal loan, student loan or a line of credit – you may be unsure what would happen if you were to stop paying your loan back. After all, an unsecured loan is based largely on a written promise to your lender to pay it back. By contrast, a secured loan like a mortgage or car loan requires collateral like a house or car, which you risk losing if payment terms aren’t met.

As you’ll see below, the consequences of defaulting on an unsecured loan can also be serious. They’re also very different from being behind, or delinquent, on payments. We’ll explain exactly what might happen if your unsecured loan were to default, and how to deal with the fallout.

Unsecured loan vs. secured loan differences

The main difference between a secured loan versus an unsecured loan is whether a borrower is required to put down collateral to back the loan. A lack of collateral means it’ll be tougher to qualify for an unsecured loan as your lender will likely require a higher credit score. Also, you’ll likely pay higher interest rates and fees than you would with a secured loan. That’s because the lender’s risk is higher with an unsecured loan than a secured loan.

Examples of unsecured vs. secured loans
Unsecured loans Secured loans
  • Credit card
  • Personal loan
  • Student loan
  • Business loan
  • Mortgage
  • Home equity line of credit
  • Car loan
  • Secured credit card
  • Payday loan
  • Pawn shop loan
  • Auto title loan

Defaulting on an unsecured loan

A loan default is different from a loan delinquency. A loan is generally considered to be delinquent the first day after a missed payment, but lenders are often willing to work with borrowers, like maybe offering a chance for partial payment. A loan usually goes into default when payments stop over the course of weeks or months – the exact time will vary by lender.

Most lenders allow a grace period before reporting late payments to credit bureaus. However, if  a loan continues to go unpaid, expect late fees or penalties, as well as a drop in your credit score; even a single missed payment could lead to a 40 to 80 point drop.

With time, a lender might send your delinquent account to a collections agency to force you to pay it back. Any collection activity against you can stay on your credit record for up to seven years.

Here’s a general timeline for unsecured loans:

 What happens if an unsecured loan doesn’t get paid?
0-30 days Grace period to make a minimum payment without incurring penalties
30-60 days Late fees and possible penalties such as increased interest rate; may be reported as a late payment to credit bureaus and drop your credit score
60-120 days Lender could ask for full amount owed. Account flagged by lender’s collections department and moved to default status. Credit card account may be closed.
120-180 days Debt discharged by lender as a loss and sold to collections agency; legal action may be taken at this stage, or debt settlement could be proposed.
270 days Student loans considered in default at this stage as they have the longest grace period of all unsecured debt

Repercussions for unsecured loan default

  • A potentially serious drop in your credit score
  • Defaults can stay on your credit report for up to 7 years
  • For federal student loans, you might see money withheld from future income tax refunds and Social Security benefits
  • Difficulty qualifying for loans in the future
  • Wage garnishment
  • Lawsuits
  • Additional court fees
  • Liens against your property or revenues
  • Additional tax obligations if your lender issues you a 1099-C form for any amount written off as cancelled debt (and which is considered taxable income to you).

Defaulting on a secured loan

If you default on a secured loan, it’s possible your lender might take steps to repossess an asset like a house or car in order to pay off your debt. If you default on a mortgage, the result is foreclosure, and it means losing your home.

In practice, borrowers and lenders usually try to work together to prevent a secured loan from going into default and triggering a repossession. For example, foreclosure is a timely and expensive process, so lenders are often willing to modify mortgage payments or offer mortgage assistance. In some states, even if you are already in default, lenders are required to give you time – like 21 days – to catch up on late payments

The timeline below shows what a borrower might expect with an unpaid secured loan. Grace periods will vary according to the lender and the type of secured loan you have.

What happens if a secured loan doesn’t get paid?
0-30 days Grace period to make a minimum payment without incurring penalties
30 days Loan may be considered to be in default; vehicles and other assets may be repossessed at this point, although more likely to occur 60 to 120 days after the last payment
120 days Foreclosure process varies by state, but  generally starts 4 months after a borrower misses a mortgage payment

Repercussions for secured loan default

As with an unsecured loan, if you default on a secured loan, you will likely see a huge drop in your credit score and also much higher interest rates on any future borrowing. But you will also face the ultimate consequence of losing the asset you used as collateral. This can include the following:

  • Your home
  • Vehicles (like a car, truck or SUV)
  • Assets like bank and savings accounts, investment accounts and jewelry

Even if your assets are seized and sold after a default, you may still owe money to your lender if the proceeds are not enough to cover the debt you owe.

How to deal with debt in collections

If you default on a loan and your debt is sent to a collections agency, consider the following steps to protect your rights as a consumer:

  • Request a debt validation letter. Ask the creditor or collection agency to verify in writing that the debt you owe is correct and valid, and that they have the right to collect. it. Beware of potential scams.
  • Complain to the Consumer Financial Protection Bureau (CFPB). If you don’t agree with the collection agency and don’t believe the debt is yours, submit a complaint to the CFPB.
  • File disputes online with the major credit bureaus TransUnion, Experian and Equifax. If the collection agency doesn’t provide the requested information to address your dispute within 30 days, your debt will disappear from the credit bureaus’ records.
  • Be mindful of statutes of limitations. Consult with your state attorney general’s office or research your state’s rules on how long different types of debt can be pursued and what your consumer protection rights are in these cases. Even one payment toward an old debt can restart the statute of limitations, so make sure you look into timelines before taking action.
  • Complain to the Federal Trade Commission (FTC) and your state attorney general if you are being contacted or taken to court for time-barred debts. If your debt is outside the statute of limitations in your state, it’s against the law for a debt collector to sue you or threaten to sue you.
  • Consider credit counseling, debt management or other strategies like debt consolidation to get out of collections. Talk to your loan servicer to see if you can work out a repayment plan or drop your interest rates to more manageable levels.
 

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