Key learning points
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A lender may sue you for not paying back your personal loan as promised.
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Payday lenders report missed payments to the credit bureaus, which can cause a drop in your credit score.
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If a lender wins a lawsuit against you, it can garnish your wages to pay off the debt.
Usually people get a personal loan because they cannot get fast financing elsewhere. Unfortunately, the financial situation can become even worse if the borrower is unable to pay back what they owe.
Depending on how long it has been since you received the loan, the lender may threaten to file a lawsuit against you and garnish your wages. Borrowers in this situation have options that may help.
What can happen if you don’t pay back a personal loan?
Although each situation may have differences, there are some typical consequences of not paying back a personal loan on time.
Withdrawals from your bank account
Most lenders will repeatedly attempt to withdraw the money from your bank account as permitted by the terms of the loan agreement. If your bank declines the transactions due to insufficient funds, the lender can initiate withdrawals for smaller amounts.
Even if the lender collects some of the outstanding balance through this method, you may still face financial hardship if other banking transactions are declined. Plus, bank fees can pile up and cost you hundreds of dollars in a short period of time.
Debt collection agencies intervene
You can expect the lender to initiate collection efforts, including repeated phone calls and letters demanding payment, while continually trying to charge your account. The lender may also sell your debt to a collection agency or hire an attorney to collect what is owed.
You may be able to stop the collection actions by requesting a postponement from the lender. Certain states have laws that require payday lenders to grant extended payment plans to borrowers upon request. Please note that these extensions often incur additional fees and interest.
Credit score drops
The lender may also report the delinquent account to the credit bureaus once it has been turned over to a collection agency. Your credit score will likely drop and the negative mark will remain on your credit report for up to seven years. As a result, you may find it challenging to secure competitive financing offers in the future.
You can take some action to rebuild your credit score after defaulting on a payday loan. First, check your credit report to identify any other delinquent accounts and bring them up to date, as payment history is the largest part of your credit score. You also want to look for errors and dispute them quickly.
Also, adjust your spending plan to free up money that you can use to pay off credit card debt in the near future. You want to do this to lower your credit utilization ratio, or the amount of revolving credit you use, since it makes up 30 percent of your credit score.
Most importantly, keep an eye on your credit report and practice responsible debt management habits so that your credit score has the best chance to improve over time.
Lender lawsuit
If the lender takes you to court, the burden of proof is on them to prove that you owe the debt. Simply ask them for documentation or the agreement you signed when you took out the loan. The judge will likely dismiss the case if the debt collector cannot provide this information. But if the lender proves that you owe something and gets a judgment from the court, you could be ordered to pay or have your wages garnished.
Quick note: If the lender threatens to have you thrown in jail, contact your attorney general’s office immediately to file a complaint.
How to Negotiate with a Payday Lender
Lenders may be open to negotiations with you because a lawsuit can cost money. You can ask the lender to extend your repayment plan. Some lenders offer this service for free, while others charge a fee.
Another strategy is to ask the lender if they will accept a debt settlement: a one-time payment that is less than what you owe. A good starting point is to pay 15 percent of the debt. Then ask to settle for a higher amount if the lender denies that request – up to 50 percent.
Before you pay off your debt, keep in mind that you may have to pay taxes on the amount forgiven if it is $600 or more. Also, paying off payday loan debt can damage your credit.
How to get the money to pay back a personal loan
Instead of ignoring a delinquent loan and potentially ruining your credit, consider these options to repay the debt:
- Apply for one peer-to-peer lending. If your credit score is low, a peer-to-peer loan is worth considering. You can find these loan products on online loan marketplaces that match potential borrowers with investors willing to lend you money in exchange for returns. You can compare multiple loans with one application. You will usually need proof of income or assets to be approved.
- Get a debt consolidation loan. A debt consolidation loan allows you to consolidate high-interest debt into a single loan product with a lower interest rate. Most debt consolidation loans have a fixed interest rate and you make equal monthly payments over a set period of time. The most competitive lending terms are reserved for borrowers with good or excellent credit. Even with less than optimal credit scores, your rate may be lower than what you received with the personal loan.
- Consider a short-term emergency loan. Credit unions and select community banks commonly offer short-term emergency loans as payday alternatives. They are usually available with slightly lower interest rates and for small dollar amounts, capped at $1,000, and may not require a credit check for approval.
- Register with one debt management plan (DMP). It should be a last resort when you’ve exhausted all your options. DMPs are available through nonprofit organizations. A credit counselor will contact the payday lender on your behalf to negotiate a customized repayment plan that fits your budget. You pay the principal balance of the loan in full, but the downside is that enrolling in a DMP can prompt other creditors to close your credit card accounts, which can cause further credit damage.
You can also try talking to friends and family or finding ways to adjust your finances to cover expenses, such as temporarily canceling streaming subscriptions or switching to a lower food budget.
How to rebuild your credit after defaulting on a payday loan
If your credit score has taken a major hit due to a payday loan default, it is possible to get back on track. These strategies will help you restore your credit health:
- Make timely payments. Payment history is the most important part of your credit score. So it is essential that you make on-time payments every month and that you keep overdue accounts current to avoid persistent negative credit reporting. Overdue accounts are not reported until the due date is 30 or more days. Therefore, work with your creditors to make a payment arrangement and avoid adverse credit reporting.
- Lower your credit utilization ratio. This figure represents the amount of your credit limit on revolving accounts currently in use. So if the total credit limit on all your credit cards is $5,000 and you owe $2,000, your credit utilization rate is 33 percent. Ideally, your credit utilization rate should be 30 percent or lower to have the best chance of having a solid credit score.
- Don’t close old accounts. Your credit age is also included in the credit score comparison. If you have old accounts in good standing, leave them open to avoid a drop in your credit account average.
- Only apply for credit if necessary: A hard question is generated every time you apply. It only lowers your score by a few points, but too many inquiries in a short time frame can significantly affect your credit score.
Most importantly, keep an eye on your credit status by checking your scores and reports regularly. If you notice any errors, immediately file disputes with the credit bureaus to have inaccurate information that could be dragging down your credit score removed.