If you stop making payments on your loan or credit cards, your creditors won’t ignore your account for long. Lenders have tools they can use to recoup the money you borrowed. But what your lender can do will depend on the type of account.
Secured and Unsecured Debt: The Differences
If you’ve missed a payment, you’re likely wondering what steps your creditor can take next. The answer will depend on whether you agreed to give up the purchased property (collateral) if you failed to make your payment (usually the case with a car loan or mortgage). If so, the debt is a “secured” debt. The collateral creates a “lien” (ownership) right which allows the creditor to take possession of it and sell it when you fail to pay. (Learn about voluntary and involuntary liens in Secured Claims and Liens in Bankruptcy.)
Not all debts are collateralized, or, secured by property. For instance, credit card balances, medical bills, and personal loans are “unsecured” accounts. If you don’t pay the debt, the creditor can’t take the property you bought without first doing more (explained below).
(For more detail, read What Are the Differences Between Secured and Unsecured Debt?)
How Does a Creditor Collect a Secured Loan?
Two things determine what a secured creditor can do to recoup a loss: the loan agreement that you signed when you took out the loan and the laws of your state.
A Creditor Can Repossess Your Car or Other Property
When you fall behind on your car, furniture, jewelry, electronics, or equipment payment, the creditor can take the property back. It’s relatively easy for the creditor to repossess a vehicle. It will probably hire a repossession agency to take it while it’s out in the open. For other personal property, like furniture and appliances inside your home, the creditor might have to get a court order to enter your property (unless you give your permission).
After a waiting period, usually outlined in state law, the lender can sell the collateral and apply the proceeds to your loan balance. If the item brings less than what you owe, you’ll likely be responsible for the remaining portion. Some states will allow you to get your property back (redeem it) by paying off the loan and the repossession expenses. (For more information, read Can a Creditor Take My Car?)
A Creditor Can Foreclose on Your Home or Other Real Estate
If you stop making your mortgage payment, or you break some other part of the mortgage contract, your creditor can take steps to sell your home at auction and use the proceeds to pay down the debt. The exact process will depend primarily on the laws of your state.
For instance, some states require the bank to sue you in court in what’s known as a “judicial foreclosure.” Others provide a more streamlined approach that starts when a lender gives you a notice of your failure to make your payment (default). (To learn more, see What Are the Differences Between Judicial and Nonjudicial Foreclosures?)
Both processes end when the bank sells the property at auction. The funds will get used to pay down the mortgage balance. You might be responsible for any remaining “deficiency” balance depending on the law of your state. (To learn more, see Foreclosure and Your Home: Understanding the Process, Your Rights, and Your Options.)
How Does a Creditor Collect an Unsecured Account?
Even though your credit card lenders or other unsecured creditors have no collateral to repossess, they still have effective weapons in their arsenals.
Phone Calls and Demand Letters
For unsecured bills (like credit card balances and medical bills), most creditors begin their collection efforts with demand letters and phone calls after you miss your first or second payment. If you continue to ignore these attempts to contact you, the creditor will either assign the account to an outside collection agency or sell the debt to another company, often for pennies on the dollar. Those collectors will continue to phone and write you indefinitely. However, an unsecured creditor cannot take more aggressive action unless it sues you (and wins a money judgment) in court. (For more about the process, see Delinquent Debt: What to Expect in Debt Collection.)
Filing a Lawsuit
If you continue to ignore your creditor’s attempts to collect, you might face a lawsuit. If you fail to defend the lawsuit—or if you lose the case—the court will enter a judgment against you for the amount owed, and the costs and attorney’s fees the creditor incurred to bring the suit. Also, the judgment will continue to accrue interest until it is paid in full. (For more, read Delinquent Debt Lawsuit: What to Expect When a Creditor Sues You.)
Taking Your Property With a Money Judgment
In most states, the judgment either automatically becomes a lien against your property, or the creditor can take steps to turn it into a lien. In effect, a money judgment changes an unsecured debt into an involuntary secured debt that entitles the creditor to take your property. In most states, the creditor will use the judgment to garnish your wages (take money from your paycheck) or levy against your bank account (withdraw the funds). (To get an idea about the steps a creditor can take, see Collecting on Small Claims Judgments.)
Reporting Your Payment History to Credit Bureaus
Failure to pay your debts will have a dramatic effect on your credit score. Creditors can report negative information about your credit account for up to seven years after you stop paying—and there’s no magic wand to erase bad credit. As long as the creditor reports the information accurately, it will probably continue to impact your credit score until it falls off the report.
Filing for Bankruptcy
One of the quickest and easiest ways to handle a debt problem is to file for bankruptcy. To learn if it’s right for you, take advantage of a free or low-cost initial consultation with a bankruptcy attorney.
Questions for Your Attorney
- Will bankruptcy stop a repossession or foreclosure?
- Will bankruptcy stop a wage garnishment?
- Should I call you if a creditor serves me with a lawsuit?