What Happens If You Stop Paying a Personal Loan?

Personal loans offer a way to access funds for various needs, from consolidating existing debt to covering unexpected expenses. When you enter into a personal loan agreement, you commit to repaying the borrowed amount, along with interest, over a set period. Failing to meet these repayment obligations can initiate a series of financial challenges, impacting your financial standing and future borrowing capacity.

Initial Stages of Non-Payment

Missing a scheduled personal loan payment marks the beginning of a process that can escalate. Your loan is considered delinquent. Lenders typically allow a grace period, often around 15 days, before assessing a late fee. These fees can be a flat amount or a percentage of the overdue payment.

During this period, lenders will contact you to remind you of the missed payment. While a payment missed by only a few days may not immediately affect your credit report, a payment that becomes 30 days past due is reported to the three major credit bureaus. This late payment mark can cause a drop in your credit score and remains on your credit report for up to seven years from the date of the missed payment.

Addressing the missed payment promptly, before it reaches the 30-day mark, can help mitigate the negative impact on your credit score.

Loan Default and Debt Collection

If payments remain unmade, the loan progresses from delinquency to formal default. Personal loans commonly go into default after 90 days of non-payment. At this point, the lender may determine the debt is unlikely to be repaid, leading to a “charge-off” status. A charge-off is an internal accounting action where the lender writes off the debt as a loss, but it does not mean the borrower is no longer obligated to pay.

Once a loan is charged off, the original lender may intensify collection efforts or sell the debt to a third-party debt collection agency. This agency purchases the debt and assumes the right to collect the full amount from the borrower. When the debt is sold, it may appear twice on your credit reports: once from the original creditor as a charge-off and again from the collection agency as a collection account.

Debt collection agencies employ various methods to recover the outstanding balance. They may attempt to negotiate a payment plan or a settlement for less than the full amount owed. The charge-off will remain on your credit report for seven years from the date of the initial delinquency that led to the charge-off.

Legal Actions and Enforcement

When collection efforts prove unsuccessful, lenders or debt collection agencies may pursue legal action to recover the personal loan debt. Filing a lawsuit is a common step, as it can lead to a court judgment against the borrower. A judgment is a formal court order confirming that you legally owe the debt.

Upon obtaining a judgment, the creditor can seek enforcement mechanisms such as wage garnishment, bank account levies, or property liens. Wage garnishment involves a court order that directs your employer to withhold a portion of your earnings and send it directly to the creditor. Federal law limits wage garnishments for consumer debt to the lesser of 25% of your disposable earnings or the amount by which your disposable earnings exceed 30 times the federal minimum wage.

A bank account levy allows the creditor to seize funds directly from your bank accounts up to the judgment amount. Unlike wage garnishment, which takes a percentage of future earnings, a bank levy can freeze funds already present in your account. While personal loans are unsecured, a court judgment can enable the creditor to place a lien on your real property. A property lien creates a legal claim against the asset, potentially preventing you from selling or refinancing it without first satisfying the debt.

Long-Term Financial Consequences

The repercussions of defaulting on a personal loan extend far beyond immediate collection attempts and can significantly impact your financial future. Negative marks on your credit report, such as late payments, charge-offs, and collection accounts, can remain for seven years from the date of the original delinquency. If a court judgment is issued, it can stay on your credit report for seven years from the judgment date.

Even if the debt is paid or settled, the record of the charge-off or judgment will persist, though its status may be updated to ‘paid’ or ‘satisfied’. This prolonged negative credit history makes it more difficult to obtain new credit, including other personal loans, mortgages, or credit cards. Lenders view a history of default as a heightened risk, often resulting in denials or higher interest rates if credit is extended.

Your credit score will likely remain suppressed for years, affecting loan approvals, housing applications, and insurance premiums. A consequence involves potential tax implications if a portion of the debt is forgiven or canceled. If a lender or collection agency forgives $600 or more of your debt, they are required to issue Form 1099-C to both you and the IRS. The IRS considers canceled debt as taxable income, meaning you may need to report it on your tax return and pay taxes on the forgiven amount.