Signature Loans: What Happens if You Don't Repay?

Signature loans are exactly what their name implies; they are loans you get with your signature alone. No collateral is required when you borrow with a signature loan. For this reason, they usually are reserved for those with good-to-great credit. However, the fact that no collateral is necessary doesn't mean you simply can walk away and not pay back the money you borrowed.

Don't Assassinate Your Own Character

In fact, of the five Cs of credit (character, collateral, capacity, conditions and capital), it's your "character," your history of paying on time (which is reflected in your credit score), that got you the loan, and it's that character (credit score) that is at stake if you don't repay. So, exactly what happens when you default on your signature loan? Here are five things lenders can do when you don't pay that can hurt your credit and finances for many years.

  1. Send your loan to collection. If you default on your signature loan, lenders may pursue collection to get the money you owe them, and it's not a pleasant process. In fact, it's usually pretty stressful. First, your lender calls you and sends letters requesting that you repay the loan immediately and in full. If you still fail to pay, the loan may be sent to a collection agency and the tactics become far more aggressive -- particularly if the loan balance is high.
  2. Report your default to credit bureaus. Even before the loan goes into default, your late payments appear on your credit report. This usually begins when a payment is 30 days late. When that happens, your credit score will drop. Once a loan goes into complete default and into internal collectors or (worse) to a collection agency, that activity shows up on your credit report as "In Collection" and your credit score may plummet. Like other damage to your character (remember those 5 Cs of credit?), it can take years to repair the damage to your credit reputation.
  3. Take you to court and garnish your wages. Your loan documents probably indicate that the lender reserves its right to take any action allowable by law to recover money you owe. These remedies may include sending a collection agency after you, or the lender may undertake to collect the arrearages itself. Defaulting on (failing to pay) your loan is likely to trigger a demand for payment in full. Depending on your location and loan terms, if you fail to satisfy this demand, your lender or its agent may sue you for the loan balance plus penalties and interest and collection costs, including legal fees. This can result in wage garnishment of up to 25 percent of your gross pay.
  4. Make getting new credit costly or impossible. Several factors determine how much difficulty you may have getting new credit. Those include the total amount of the defaulted loan, how much you fail to repay and how long the loan stays in collection before you repay. Interest rates for new credit (if you're lucky enough to be offered credit) will be much higher than you're used to paying.
  5. Create a tax obligation. If you default on a loan outside of bankruptcy proceedings, your lender can issue you a 1099-C form for the amount it writes off. That money becomes taxable income to you.

Default: The Bad and the Ugly

Let's face it; the consequences for defaulting on a signature loan can be severe. Your reputation or credit score is adversely affected (perhaps for years) if you don't repay. You may be sued and your wages may be garnished. If you borrow with a signature loan, make sure you'll be able to repay it as agreed -- preserving your good character, future credit opportunities and even your sanity.

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