Maybe you’ve tried all you can to pay off your debts or at least make monthly payments. You’ve cut down on frivolous expenses while adhering to a draconian budget. Yet, nothing you do seems to work, and your debt keeps rising. The emotional stress and sleepless nights mount up. And then suddenly, you reach a breaking point and can no longer afford to pay up.
Being in the situation just described can be extremely scary. Where do you go from here? What should you expect? In this post, we explore things that can happen when you don’t pay your debt.
Secured Debts versus Unsecured Debts.
First off, it’s important to note the distinction between secured and unsecured debts because it determines what actions creditors can take.
Secured debt is a debt that is backed with collateral. If you default on the loan, the creditor can seize the collateral, sell it, and use the proceeds to pay off the debt. Examples include mortgages (which are backed by the houses themselves) and auto loans (which are backed by the vehicles themselves).
On the other hand, unsecured debt is a debt not backed with collateral. Hence, the creditor is not entitled to take your property to clear off your debt – unless ordered otherwise by a judge.
What Happens When You Cannot Pay Secured Debts
Here are some things that will happen when you fail to pay secured debts:
Repossession is the act of retaking an asset/property when a buyer defaults on payment. If you miss one or two payments on your auto loan, the lender is legally entitled to repossess the car, sell it, and use the money to cover your debt and the attorney fee incurred. Lenders do not require a court judgment to repossess your car.
Note that if the proceed from the sale of the vehicle is lower than the amount you owe, you will still owe the lender the difference, which is referred to as a “deficiency”.
Business machinery, equipment, and assets can also be repossessed if the business owner can no longer make the required payments.
Foreclosure is the act of taking possession of a mortgaged property when the mortgagor fails to keep up with mortgage payments. Why is that? Because when you take out a mortgage, the home itself is used as collateral.
In some states, the lender must file a lawsuit to foreclose on a house (judicial foreclosure). In other states, there’s no need for filing a lawsuit (nonjudicial foreclosure).
Note that your house can also be foreclosed if you used it as collateral for a business loan or line of credit. That’s why you need to think carefully before using your house to back up another loan.
What Happens When You Cannot Pay Unsecured Debts
When you cannot pay off unsecured debts, here are some of the things creditors may do:
- Pass your debt to a collection agency
Your creditor may employ the services of a debt collector. The debt collector then becomes responsible for collecting your debt. First off, they send you a written notice stating how much you owe, the company you owe, and how you can make payment.
If you’re able to pay in part or in full, the debt collector gives the money to your creditor while receiving between 24 to 45% of the total amount as payment for their services.
Alternatively, your creditor may choose to sell your debt to a debt collection agency for as low as 4 cents for every $1 of debt. In this scenario, the collection agency keeps all of the money, if they’re able to get all or part of the debt from you.
- You might get sued
If you owe a little amount of money – like less than $100 in credit card debt – your creditor may write it off as a business loss and deduct it for tax purposes.
However, if you owe a considerable amount – like $7,000 – you might get sued by the creditor or collection agency, as the case may be. The judge then decides the case. If the creditor wins the case, your creditor may be able to take cash from your business’s bank account.
Your creditor may also be allowed to garnish your wage. Under wage garnishment, a certain percent is automatically taken from your monthly salary until you clear off your debt. Federal laws set the maximum limit for wage garnishment as 25%.
If you refuse to show up to court, you automatically lose the case.
Negative Impacts of Failure to Pay Your Debt
- Your credit score will take a hit.
If you had a great credit score before missing a payment, expect to lose as much as 100 points from your credit score. If you already had a poor score, it will drop by a smaller margin. Having a bad credit score impacts your creditworthiness, making it more difficult to get new loans with favorable terms.
- It will hunt you for years.
If you fail to pay your debt, it will be reported in your credit report. Unpaid judgments will stay on your credit report for seven years or until the state statute of limitations expires, whichever is longer.
In conclusion, know that you cannot be arrested for failing to pay your debts. Unless, of course, you deliberately refuse to pay child support, alimony, taxes, or you incurred the debt through fraudulent activities.
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