The Consequences of Defaulting on an Unsecured Personal Loan
Unsecured personal loans are issued to consumers without collateral. Lenders typically offer them with higher interest rates, and are selective with whom they choose to approve.
As such, these loans are considered high-risk for the lender. This is because without collateral, there is no guarantee the borrower won’t default. And while the lender won’t seize an asset if the borrower defaults on their unsecured personal loan, the consumer will still face major financial repercussions:
The borrower will likely incur financial penalties.
To deter borrowers from making late payments, lenders of unsecured personal loans typically impose financing charges such that the late fee on a missed payment goes up every 30 days.
In other words, the principal amount the borrower owes will continue to increase until they recover their debt from default. And if they do default on the loan, they may be held responsible for repaying the total principal and interest owed for the entire loan.
In addition, their credit will suffer.
By the time a borrower defaults on an unsecured personal loan, they have already experienced significant credit penalties. Consumers compromise their credit long before they have officially defaulted on their loan; the process begins when their payment is 30 days past due. Then, the borrower’s credit will drop again when the loan payment is 60 days past due.
After 90 days, a collections agency will take over the debt, and the lender will write the loan off as a default. At this time, the borrower’s credit score will take an even greater hit.
Once they have officially defaulted on their unsecured personal loan, the borrower may be taken to court.
This is the point where, if the borrower had been issued a secured personal loan, the lender would seize the asset for which they were given the title. The collateral would be liquidated to pay off the loan, and the borrower could start rebuilding their credit.
However, without any assets on the line, the lender may take the borrower to court. The judge assigned to the case will determine whether the borrower had a legitimate reason to default on the loan — a debilitating injury or an unexpected layoff would likely sway their decision-making — and order the borrower to repay the amount they owe.
In some cases, the borrower and the lender will settle their case out of court, and come up with a structured repayment plan independently. Borrowers should also note that creditors are unlikely to take smaller amounts of unsecured debt to court, as legal fees and the overall hassle of suing someone may not make it worth their while. This, of course, is no reason to willingly default on an unsecured personal loan.
The borrower may have their wages garnished.
If the borrower is taken to court, and a judgment is made against them, their wages may be garnished to ensure they pay back their unsecured personal loan. Fortunately for the borrower, federal law limits how much creditors can take from each paycheck. The total amount that can be garnished is capped at 25% of their disposable earnings, or the amount by which the borrower’s weekly wages exceed 30 times the federal minimum wage — whichever amount is lower.
Ultimately, while life brings us unexpected surprises, and we cannot always pay off our debts as planned, borrowers must acknowledge that loan contracts are legally binding, and that there are consequences to defaulting on a loan.