Unsecured Debt: What It Is and What Happens if You Don’t Repay It

Unsecured debt is money you borrow without pledging property as collateral. Credit cards, personal loans, and medical bills all fall into this category. Lenders can’t automatically seize your belongings if you miss payments. But they can still pursue collection actions, lawsuits, or wage garnishment.

Missing payments damages your credit and increases your balance through fees and interest. Default becomes likely if the debt remains unpaid. If you’re struggling, you have options. Credit counseling, debt consolidation, or bankruptcy can help you get relief.

What Is Unsecured Debt?

Unsecured debt is money you owe that isn’t tied to specific property. If you don’t pay, creditors can’t automatically take your belongings. They must pursue collection actions through other means.

Banks and credit card companies that issue these loans are called unsecured creditors. Because unsecured debts aren’t backed by property, they’re often easier to discharge in bankruptcy.

Common Types of Unsecured Debts

You likely have several types of unsecured debts. The most common include:

• Credit cards
• Personal loans
• Medical debt
• Old utility bills
• Past due rent and lease payments
• Unpaid cellphone bills
• Deficiency balances after car repossession
• Child support
• Unsecured lines of credit
• Most tax debts

Student loans are also unsecured debts. But they work differently from other debts on this list. You typically sign a promissory note when taking out student loans. That’s a legal promise to repay the money.

Student loans aren’t tied to property like a house or car. But they come with special rules that make them harder to eliminate in bankruptcy. Still, you can discharge federal student loans if you meet certain requirements.

How Are Secured and Unsecured Debts Different?

When you borrow money, the loan will be either secured or unsecured. The difference is whether the loan is tied to collateral.

Secured Debts Are Tied to Property

Secured debts are backed by collateral. Lenders have a legal right to take the property if you don’t pay.

Common examples of secured debts include:

• Car loans (the car is the collateral)
• Home loans or mortgages (the house is the collateral)
• Secured credit cards (backed by a cash deposit)

If you miss payments on a secured debt, lenders can repossess the car or foreclose on the home. They can also keep any deposit you made. Because lenders have a way to recover their money, secured debts usually have lower interest rates.

Unsecured Debts Aren’t Tied to Property

Unsecured debts don’t have property backing them up. If you don’t pay, creditors can’t just take something from you. For example, credit card companies can’t seize items you purchased with the card.

If you fall behind on unsecured debts, creditors will start calling and sending letters. If the debt isn’t paid, they can sue you. But they must win in court and get a judgment first. Only then can they garnish your wages or freeze your bank account.

Because unsecured debts are riskier for lenders, they carry higher interest rates.

What Happens if You Don’t Pay a Loan Back?

Missing one payment isn’t the end of the world. But falling far behind on unsecured loan payments has serious consequences.

Here’s what typically happens first:

• Your credit score may drop. You’ll find it harder or more expensive to get new credit. But scores can recover over time with positive payment history.
• Late fees and higher interest charges add up. Even small fees grow quickly and make it tougher to catch up.
• You might lose any grace period. Grace periods give you extra time after the due date to pay without charges.
• Overdraft fees can happen with automatic payments. If your account balance is low, your bank charges a fee when payments go through.
• The account could move from delinquency to default. Delinquency means you’ve missed one or more payments. Default means the account has been unpaid for several months. Lenders may send it to collections or sue you.

If you default on the loan, even more serious consequences follow.

What Can Happen if You Default on an Unsecured Loan?

If an account goes into default, the lender takes more serious steps to collect. Default typically means several months without payment.

Here are the possible consequences:

• Collections calls and letters: The lender may turn your account over to collections. These collectors will call and send letters asking for payment. They must follow rules under the Fair Debt Collection Practices Act (FDCPA). They can’t harass you or share details of your debt with others.
• Debt collection lawsuit: The creditor or collection agency may sue you in court. If you don’t respond to the lawsuit, the court will likely issue a judgment by default.
• Wage garnishment: If a creditor wins a judgment, they may take money directly from your paycheck. State laws set limits on how much they can take.
• Bank account levy: A judgment can allow creditors to withdraw funds directly from your bank account.
• Property liens: A judgment may result in a lien on your property. That affects your ability to sell or refinance it later.

Defaulting on an unsecured loan leaves a lasting mark on your credit report. Judgments can remain on your credit report for up to 10 years. Late payment history usually stays for seven years.

While these consequences feel intimidating, you have options. Many people work out payment arrangements or settle their debts. Others explore bankruptcy to stop collections and get a fresh start.

What Should You Do if You’re at Risk of Defaulting?

Unsecured debt like credit cards, medical bills, and personal loans adds up quickly. Unexpected expenses make it even harder to keep up. If you’re finding it hard to make minimum payments, you have options.

Here are ways to manage your debt and protect your income:

• Contact the lender directly
• Get a free consultation with a nonprofit credit counselor
• Refinance the loan or get a new loan
• File bankruptcy

Contact the Lender Directly

A great first move is contacting your lender directly. Explain your situation and ask if they can help. Some lenders will let you skip one or more payments during financial hardship.

You can also ask about lowering the monthly payment. Request waived late fees or temporarily reduced interest rates. You’ll usually have more options if you contact the lender early. Don’t wait until you’re deep in default.

Get a Free Credit Counseling Session

Many people explore working with a nonprofit credit counseling agency. A credit counselor can review your full financial situation. They’ll walk you through your options, including:

• Simple budgeting to better manage your finances
• Setting up a debt management plan
• Negotiating a debt settlement agreement
• Consolidating your debts
• Filing bankruptcy

If you’re not sure where to start, sign up for a free credit counseling session. Our partner Cambridge Credit Counseling is a nonprofit with nationally certified credit counselors. They can help create a personalized action plan for you.

Research Refinancing

If a debt management plan doesn’t feel right, consider refinancing or consolidating. You take out one new loan with better terms to pay off existing debts.

Debt consolidation can sometimes help you:

• Get a lower interest rate
• Lock in better repayment terms
• Reduce your monthly payment amount
• Make budgeting easier with one payment

People often use this approach for high-interest debts like credit cards.

Common ways to consolidate debt include:

• Personal loan: An unsecured loan you use to pay off other debts
• Credit card balance transfer: Moving balances to a card with low or 0% introductory interest
• Home equity line of credit (HELOC): A loan that uses your home as collateral

A HELOC may help you get a lower interest rate. But it turns your unsecured debt into secured debt. You risk losing your home if you can’t make the payments.

File Bankruptcy

If you’re taking on new loans just to cover existing payments, you need a bigger solution. For many people, that solution is Chapter 7 bankruptcy.

Bankruptcy is a legal process that can erase most types of unsecured debt. Your credit card balances, medical bills, payday loans, and personal loans can all be discharged.

One of the most powerful features is the automatic stay. The court order goes into effect as soon as you file. It stops most debt collection activities right away. That includes phone calls, wage garnishments, and pending lawsuits.

Need to explore your options? Speak with a bankruptcy attorney for free to see if Chapter 7 is right for you.

How To Eliminate Unsecured Debts With Bankruptcy

When unsecured debts feel impossible to manage, Chapter 7 bankruptcy offers real relief. In most cases, it takes only a few months to get the discharge. That court order wipes those debts away and gives you a fresh start.

Most unsecured debts are eliminated in bankruptcy. Your debts likely include:

• Credit card balances
• Personal loans
• Medical bills
• Old utility bills
• Some types of personal judgments

Once these debts are discharged, you no longer have any legal obligation to pay them. But some unsecured debts aren’t automatically forgiven in Chapter 7.

Unsecured Debts That Might Not Be Discharged

You must list all your debts on your bankruptcy forms. But some debts can’t be discharged in Chapter 7 bankruptcy. Recent income tax debt and domestic support obligations like child support can’t be eliminated.

Student loans are a special case. They aren’t automatically discharged like other unsecured debts. But sometimes federal student loans can be discharged in bankruptcy.

Student Loans

Most student loans aren’t automatically discharged in bankruptcy. You can only eliminate them by filing a separate lawsuit in your bankruptcy case. That’s called an adversary proceeding. You must prove that paying them would cause undue hardship.

The process can be difficult, but some people qualify. Even if your student loans aren’t discharged, wiping out other debts makes it easier to manage payments. You might also qualify for income-driven repayment plans or other federal relief options.

Recent Income Taxes

Some income tax debts can be discharged in bankruptcy. But only if they meet specific rules. Usually, the tax debt must be at least three years old. You must have filed your tax returns properly.

Domestic Support Obligations

Debts like child support and alimony can’t be wiped out in bankruptcy. Filing bankruptcy doesn’t erase unpaid child support or alimony you already owe. These debts have special protection under the law and must be paid in full.

How Is Unsecured Debt Treated in Chapter 13 Bankruptcy?

Unlike Chapter 7 bankruptcy, which wipes out most debts in a few months, Chapter 13 takes a longer-term approach. Instead of erasing your debts right away, you commit to a repayment plan. That plan lasts three to five years.

In Chapter 13 bankruptcy, you propose a plan to repay some or all of your debts. You pay based on what you can afford. You’ll make one monthly payment to a bankruptcy trustee. The trustee distributes that money to your creditors.

Certain debts must be paid in full during your plan. Child support and recent taxes fall into this category. Others like credit cards, medical bills, and personal loans may only receive partial payments. Some may receive nothing at all.