What Happens If You Don’t Pay Back 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 auto 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, including wrecking your credit. They’re also very different from being behind — also known as being delinquent — on payments.
Let’s look at exactly what might happen if you default on your unsecured loan, and how to deal with it, by answering these questions:
On this page
- What is an unsecured loan?
- When is a loan considered in default?
- What happens if you don’t pay back an unsecured loan?
- How can you avoid defaulting on a loan?
- What can you do after you default on a loan?
- Unsecured loan vs. secured loan: What are the differences?
- How should you deal with debt in collections?
What is an unsecured loan?
An unsecured loan is a type of loan that doesn’t require borrowers to put down a valuable asset, like a vehicle or savings account, as collateral. Instead a lender relies on your personal credit score as a way to assess the risk of lending to you. As a result, unsecured loans often require higher credit scores for approval.
One common form of unsecured loans are personal loans. Personal loans have fixed monthly payment plans and typically range anywhere from $1,000 to $50,000. You can check out our list of unsecured personal loans lenders to get an idea of the terms and rates that these loans usually carry.
When is a loan considered in default?
A loan default is different from a loan delinquency. A loan is generally considered to be delinquent debt 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.
What happens if you don’t pay back an unsecured loan?
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, wage garnishment, 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:
| 0-30 days | Grace period to make a minimum payment without incurring penalties |
|---|---|
| 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 the full amount owed. Account flagged by the lender's collections department and moved to default status. Credit card accounts 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 |
Once a loan has gone into default, a few things could happen:
- A potentially serious drop in your credit score
- Defaults can stay on your credit report for up to seven 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 canceled debt (and which is considered taxable income to you).
Defaulting on a peer-to-peer loan
When someone defaults on a peer-to-peer (P2P) loan, the investor who offered up the funds in the first place walks away empty-handed, which is why many P2P platforms are particular about who they lend to.
Should you default, the lending platform may follow a similar route as other unsecured lenders. P2P companies may report your missed payments and any defaults to the credit bureaus. They may also continue to try to collect your payments as well as terminate your loan agreement.
How can you avoid defaulting on a loan?
If you’re looking ahead at your finances and see that you are unable to make your next payment on your unsecured loan, it’s better to reach out to your lender as soon as possible. By getting ahead of the issue, your lender may be willing to work with you to set up a payment plan that fits better with your current financial situation or even pause your payments.
If a new payment plan with your lender isn’t going to work out, here are several other options to consider:
- Rework your budget: Reorganizing your budget and reevaluating your spending habits to better fit your financial situation can be a straightforward way to make sure you can afford your loan payments. The 50/30/20 rule is the classic approach to budgeting in which you allocate 50% of your income toward your needs, 30% toward wants and 20% toward savings and debt.
- Consider debt consolidation: By consolidating your debt into a personal loan, you may be able to cut down on the large payments you’re making as well as secure a lower interest rate. Debt consolidation loans allow you to roll multiple debts, like credit cards, into a single loan that can give you the ability to pay off your debts faster. You may also refinance personal loans to cut down on fees and secure better rates and terms.
- Contact a debt counseling service: If you need support working out a budget, consider debt counseling as a low-cost means to get on top of your finances. Because debt counseling services are typically offered by nonprofit organizations, they often have little to no fees. Debt counseling organizations can help you do everything from creating a debt management plan to filing for bankruptcy.
What can you do after you default on a loan?
Just because you default on a loan doesn’t mean it’s the end of the road as far as your next steps. Here’s what you can do should you default on an unsecured loan:
- Contact a lawyer: If you’re being sued by a debt collector or lender, it may be time to seek legal advice from an attorney. By not responding to a debt collection lawsuit, your case may be given a default judgment in favor of the plaintiff (the debt collector).
- Reach out to a debt counseling agency: A debt collection agency can help guide you to the next steps if you default on an unsecured loan. They can also help you file for bankruptcy if that is the right next step for you.
- Understand your rights: Knowing how to manage debt collectors calling you about a defaulted loan can be intimidating. However, keep in mind that you still have rights under the Fair Debt Collection Practices Act (FDCPA) and debt collectors must still operate within the bounds of the law.
Unsecured loan vs. secured loan: What are the 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 with a secured loan.
| Unsecured loans | Secured loans |
|---|---|
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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.
| 0-30 days | Grace period to make a minimum payment without incurring penalties, typically 15 days |
|---|---|
| 0-30 days | Grace period to make a minimum payment without incurring penalties, typically 15 days |
| 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 three to six 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 default, you may still owe money to your lender if the proceeds are not enough to cover the debt you owe.
How should you 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.