What happens if you can't pay back an unsecured loan?

Financial hardships can strike unexpectedly, and unfortunately, all it takes is a job loss, medical emergency or economic downturn to quickly transform what was once a manageable loan into an overwhelming burden. But while you may be struggling to make ends meet and keep up with your debt repayments, the obligation to repay what you borrowed remains. And, if you default on those obligations, you can find yourself in even deeper trouble over time. 

For example, unsecured loans — which are loans that are not backed by collateral like your home or car — offer big benefits to borrowers, but they come with their own set of consequences if you default. With secured loans, lenders can simply repossess the asset tied to the loan if you quit paying. Unsecured debt, however, creates a more complex situation when the payments stop.

Understanding what happens when you can't pay an unsecured loan isn't just about knowing the penalties, though. It's about recognizing your options before the situation spirals. So, whether you're currently struggling with unsecured loan payments or simply want to understand the potential risks, it's critical to know the consequences and available solutions to help you navigate these financial difficulties more effectively.

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What happens if you can't pay back an unsecured loan?

When you miss payments on an unsecured loan, a predictable sequence of events begins:

• Late fees and penalties: These kick in first, typically after a grace period of 10 to 15 days. Late fees and penalties can add significant amounts to your monthly payment amount, making it even harder to catch up.
• Credit score damage: Damage to your credit score follows quickly. A single 30-day late payment can drop your score by 50 to 100 points. Lenders report delinquencies to credit bureaus at 30, 60, 90 and 120 days past due, with each stage causing additional damage.
• Collection calls and letters: Contact from your creditors will increase in frequency and urgency. These initially come from the original lender, but after 90 to 180 days of non-payment, your debt is typically sold to third-party collection agencies who may be more aggressive in their approach.
• Legal action: Lawsuits become a possibility once you're significantly behind. The lender or collection agency may sue you to obtain a judgment, which can lead to wage garnishment (taking money directly from your paycheck) or bank account levies. 

Even if you avoid legal action, defaulting on an unsecured loan can affect your financial future. You may find it harder to get approved for credit cards, mortgages or even rental agreements. Some employers also check credit reports when hiring, so defaulting could impact job prospects.

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Can unsecured loan debt be written off?

Unsecured loan debt does not simply disappear in most cases. However, there are circumstances where it may be written off. For example, if your lender determines that collecting the debt is impossible, they might charge it off, meaning they remove it from their books. However, this doesn't mean you're free from the obligation — collection agencies can still try to recover the money.

Another possibility is that the statute of limitations on debt collection expires. This varies by state but typically ranges from three to 10 years. Once the statute of limitations runs out, lenders or collection agencies can no longer sue you for the debt. However, they can still attempt to collect it informally.

Bankruptcy is another route where unsecured debt can sometimes be discharged. If you file for Chapter 7 bankruptcy and qualify, some unsecured debts may be wiped out. However, this has long-term consequences, including a significant hit to your credit score and potential difficulty obtaining loans in the future.

How to get rid of unsecured loan debt

If you're struggling to repay your unsecured debts, it may help to explore these debt relief options:

• Debt consolidation: This involves taking out a new loan with a lower interest rate to pay off existing debts, simplifying the repayment process and reducing overall costs.
• Debt forgiveness: With debt forgiveness, you or the debt relief company you work with negotiate with your lenders or creditors to pay a reduced amount as a lump sum. 
• Debt management: A credit counselor can help you create a structured repayment plan that includes lower interest rates and fees on your debt, making repayment more affordable.
• Bankruptcy: If your financial situation is dire, filing for bankruptcy may be a last resort. Chapter 7 eliminates certain unsecured debts, while Chapter 13 restructures debts into a manageable payment plan.

The bottom line

Failing to repay an unsecured loan creates a cascade of increasingly serious consequences, from immediate financial penalties to potential legal actions. However, multiple pathways exist to address unmanageable debt before it reaches crisis levels. The most important step, though, is taking action as early as possible. And, remember that resolving debt problems takes time, and quick fixes usually come with significant drawbacks. By developing a realistic plan instead, you can navigate through financial hardship while minimizing long-term damage to your financial health.