The Dangers of Defaulting on an Unsecured Personal Loan

An unsecured personal loan is issued without collateral. These loans are considered high risk to lenders because there is no guarantee against default. As a result, the borrower on an unsecured loan will typically see higher interest rates. However, many borrowers prefer this option despite the expense because it is technically lower risk to the borrower. Just because the lender will not collect an asset in the case of default, though, does not mean there is no danger in defaulting.

Credit Penalties

The first thing that occurs when a borrower approaches default on a personal loan is a significant drop in credit. This occurs, for starters, when the loan goes 30 days past due. An even greater drop will post after the loan is 60 and 90 days past due. At this point, the debt will likely be turned over to a collections agency if the borrower does not respond to the lender's attempts to collect. The lender will write the loan off as a default, and the borrower's credit will drop to the lowest levels possible. Regardless of the size of a loan, if it goes into default and moves to a collections agency, the credit score of a borrower will take a large hit.

Financial Penalties

To provide disincentives for late payments, unsecured personal loan lenders will impose financing charges. A borrower will find the late fee on a missed payment typically goes up with every 30 days the payment is late. As a result, even if a borrower can recover a debt from default, the principal amount owed will only get larger while the debt is unpaid. If default does occur, the borrower may be responsible for repaying all principal and interest for the entire life of the loan, even if the loan contract technically has many more years to mature.

Lawsuit

When you secure a loan, the lender will come seize the collateral at this point. The collateral is liquidated to partly or fully pay off the loan. When there is no collateral, though, a lender does not have this ability. The lender will not simply walk away. If the amount is significant, the lender will likely take the loan before a judge. The judge will determine if the borrower has any legitimate reason for allowing the loan to default, such as a serious illness or joblessness. In the absence of any unforeseen and unpreventable reason for default, a judge will require the loan be paid.

Wage Garnishment

In order to assure a borrower repays a debt by court order, it is possible a judge will order the garnishing of wages. This is most common on a senior type debt, such as a debt to the IRS or on a mortgage. However, even an unsecured personal debt can result in the forced garnishment of wages or even forced liquidation of a particular asset. A loan contract is legally binding; if a borrower does not hold up his or her end of the deal, the legal system can enforce regulation to assure the lender gets paid.


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