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Inflation is high, the recession is here and it is understandable that many people may be wary about meeting their financial commitments. However, it is important to understand what happens if you can’t pay back a personal loan.
So, here we’ll explore this topic in more detail, so you can understand the process of non payment and its implications.
What Happens Technically When You Stop Payments?
What you can expect when you stop making payments on a personal loan will vary according to your specific loan terms and when you missed the first payment. However, there is a typical timeline that is divided into various stages.
- Up to 30 Days: Generally, lenders will not report any missed personal loan repayments to the credit bureaus until at least one billing cycle has passed. This is typically 30 days, so if you can manage it and can bring the account up to date before 30 days, you can prevent a late payment from being recorded on your credit history. However, depending on your lender, you could face a penalty or fee for being even one day late. This could be a percentage of the outstanding loan balance or a set fee.
- 30 to 60 Days: Once your payment has reached 30 days past the due date, it will be considered delinquent. At this stage, lenders report your payment as missed to the credit bureaus. Unfortunately, this will be kept on your credit report for as long as seven years.
- 60 to 90 Days: Your lender will likely continue contacting you to request payment. For each 30 day increment that passes when you don’t pay, your missed payments will be documented on your credit report.
- 90 to 120 Days: After up to six months of missed payments, which can vary according to your lender, your account will move from delinquent status to default. When you default on your loan, it essentially means that you have failed to repay your loan as per the terms of your personal loan agreement.
- 120 Days Plus: At this stage, the lender will likely “charge off” your account, as you have missed six months of payments, but some lenders reach this stage sooner. A charge-off will appear on your credit report and indicates to anyone searching your credit report that the lender has given up trying to collect the outstanding amount. Generally, at this stage, lenders will sell your debt to a third party collections agent.
While you’re still responsible for the debt, the collection agency will take over attempting to collect the balance due. When a debt is with a collection agency, it is considered to be a separate account and will show on your credit report as “Collections”. You may also be sued for the payment and this could mean wage garnishment or a lien being put on your home.
What Happens to Your Credit If You Can't Pay It Back?
The technicalities of what can happen may seem a little out of context, so it is important to appreciate the effects of not paying back your personal loan on your day to day life.
Payment history is one of the most important factors when calculating your FICO store. In fact, your payment history accounts for approximately 35% of your score, so just one missed payment can have a significant negative impact on your credit.
While if you have an extensive history of good credit, one missed payment is not likely to cause a massive decline in your score.
However, if you only have a short credit history, with only a few accounts on your report, a missed payment could cause a significant drop in your score.
The longer that you miss payments, the greater the damage done to your credit report. Each additional missed payment will show up on your history, further lowering your credit score. Next time, you won't be able to get a loan with a credit score lower than 550.
While having a delinquent account is bad enough on your credit report, when it moves to default status, it creates a serious negative mark on your credit history.
Even if you get your finances in check and pay off the debt, the default status will still be seen on your credit report for up to seven years.
If you don’t bring your account back up to date, your loan is likely to be charged off and sold to a collection agency.
This will mean that you not only have a charge off on your account, but you’ll also have a new collections account on your account, which means a further negative impact on your score.
If the collection agency has difficulty collecting the outstanding balance, they may sue you. If they are successful, the court may order wage garnishment, a lien or other serious financial consequences.
If your wages are garnished, you will have less income and you could have even greater difficulty managing your debt obligations, which could further impact your credit score.
All of the above effects will combine to make it more difficult to obtain credit in the future. The requirements for a personal loan and other types of credit can be higher now.
This means that if you want to refinance your debts now or even look for a mortgage or auto loan, for up to seven years, you are likely to have greater difficulty being approved.
If you have an account in delinquent or default status, and you want to try to refinance your debt, you are likely to find that you won’t be able to access the most competitive rates.
This means that you may end up paying far more on a new loan, which can have a long-term impact on your financial well-being.
What To Do If You Can’t Pay Back a Personal Loan
Fortunately, you don’t need to simply wait for your account to transition to default status. There are a number of things that you can do if you find you can’t pay back a personal loan.
- Speak to Your Lender: If you have concerns that you may not be able to stick to your repayment schedule, the best thing to do is speak to your lender. Explain your circumstances and why you have missed or may miss a payment. Most lenders will arrange a temporary payment plan that can help you to get back on track. For example, if you’ve missed a payment, your lender could allow you to pay extra over the next five or six payments to bring your account up to date.
- Consider a Debt Management Plan: If you are struggling overall with your finances, you may want to consider a debt management plan. This will involve partnering with a credit counselor and each month you will make one payment and your credit counselor will disperse the funds to your creditors. Your credit counselor may be able to negotiate lower interest rates or interest freezes, so you can take an active stance on tackling all of your debt obligations. However, you should be aware that many debt management plans do have a start-up and monthly fees.
- Consider a second job – if you need money, getting a second job and making money online or offline can be a good source of income that can help you earn money toward your personal loan debt.
- Evaluate Debt Consolidation Loans: A debt consolidation loan will allow you to combine all of your debt into one loan. This means that you have one monthly payment and you don’t need to worry about managing multiple accounts. A debt consolidation loan will not erase any of your debt, and you’ll still need to repay the full amount, but you can take the loan on a longer term to potentially reduce your monthly financial costs.
- Use Home Equity: If you have significant home equity, you could leverage this via a home equity loan or a line of credit. These options allow you to access a lower rate since your new borrowing is secured against your home. A home equity loan is different from a personal loan – this reduces the risk for the lender, but it does put your home at risk if you default on your new loan.
- A 401k Loan: As a last resort, you could use a 401k to settle your outstanding debt. However, this could have long term financial implications. While the requirements for a 401k loan are more flexible, you will lose out on compounding interest and could pay more in taxes. You’ll need to consider your options carefully, and some plan providers do not permit a 401k loan, but it could be a way to avoid high interest debt
The Bottom Line
If you’re having financial difficulties and may be struggling to pay back a personal loan, it is important to act quickly. The problem will only get worse, so try to be proactive and start dealing with the issue immediately.
If you speak to your lender, you may find that they offer some excellent options that will minimize the impact on your credit score.
This depends on the lender and the debt collection process.
If you hold a bank account with your personal loan lender, it may be written in the terms and conditions that they could use funds in your bank account or they may choose to close your bank account as you are considered too high a risk.
However, in most cases, while you may struggle to get further credit, a personal loan default should not have a massive impact on your bank account.
The default will be recorded on your credit report, and your credit card issuer may see this if they are evaluating whether you should receive a rate change or increased credit limit.
If your credit has been significantly impacted, your credit card issuer may reduce your credit limit.
Yes, you can pay off personal loans early but some personal loans do have an early repayment fee. This means that if you pay off the loan ahead of the repayment schedule, you could end up paying a fee which is a percentage of the loan amount or a set fee.
Typically, your first repayment will be scheduled within 30 days of taking out the loan, but the specific date for the first payment will be detailed in your loan terms and conditions.
Your lender should provide a repayment schedule, which will show when and how often you’ll need to make a repayment.
Yes, failing to repay your personal loan can have serious financial consequences for you and your credit report.
If you default on a secured personal loan such as cash secured loan or shared secured loan, the lender has the right to seize the item or property used to secure the loan. The lender can then sell the security to recoup the outstanding debt.