I did a little research on what the consequences are for borrowers who default on unsecured loans. The following is a short list and by no means complete:
Why defaulting on an unsecured loan is a really bad idea:
- Default on any loan, and for the next 5 – 7 years (longer in some states), you may find it impossible to get another loan for anything, including a house, car, school, credit cards, personal loans, emergencies, medical treatment, etc. In essence, you’re screwed. There are high risk companies that may loan, most notably the buy-here pay-here car loan sharks and pay-day loan sharks, but you will pay ridiculous interest rates and may suffer serious consequences if you miss even one of the required WEEKLY payments. That’s a very scary road to be on.
- For military members loan defaults carry serious consequences. “The number one reason people in the service lose their security clearance is because of financial problems. And that's something that we absolutely now have to address”, Secretary of Defense Leon Panetta said in a press conference last October (2012) at the Pentagon. A security clearance investigation is an inquiry into an individual’s loyalty, character, trustworthiness and reliability to ensure that he or she is eligible for access to national security information. Investigations consist of checks of national records and credit checks, among other things. Without proper security clearance a soldier’s eligibility for promotion and pay raise is doubtful. More desirable jobs and/or better assignments and locations become unlikely. Defaulting on loans while in the military carries a heavy price.
- A poor financial past can hurt job seekers in their job search. Today many companies check job applicants' credit history as a part of a background check. To an employer, a poor credit history may equate to a higher risk employee with a greater risk of job failure; a lack of responsibility, lack of financial understanding, and a lack of seriousness. Within tight labor markets employers may quickly “weed out” applicants with poor credit histories, and there’s nothing illegal about it, as long as permission is given by the applicant for the credit check. So what’s going to show up? Delinquencies, bankruptcies, judgments, liens and a list of your loans, mortgages and credit-card accounts; a complete tell-all profile of your past and present financial dealings. In short, good luck landing a good job with a poor credit history.
- Here’s something that may surprise: Got turned down for a promotion and can’t figure out why? Some companies check credit histories when employees are considered for promotions, so you can't assume that because you have a job at the company your personal information is going to remain personal. Especially where there is competition for a position, a poor credit history may hold you back. Think about that the next time you’re late on a payment.
- Default on any Prosper or Lending Club loan, and according to the prospectuses of both platforms, the defaulter can never borrow again on these platforms. That’s a shame because as many lenders here believe, this may well be the way of the future for consumer borrowing. Defaulting here could result in long term unintended consequences for the defaulter. Borrowers also may be screwing over a lender who could possibly be their neighbor, a family member, or a friend.
- Default on a loan with one lender, and most likely other lenders will quickly find out through one of the 3 credit reporting agencies in the US (TransUnion, Experian, or Equifax) that you’ve become a high risk borrower. The consequences of becoming a high risk borrower can be devastating to your other accounts, even if they’re in good standing. Credit card companies may (and often do) react to high risk card holders by immediately trimming the available credit on their card, often to a very low limit or to an amount equal to their outstanding balance. The effect of this will further increase the credit utilization ratio, thus lowering the score even further, and creating a vicious downward credit score spiral. Borrowers are often surprised when letters come in the mail that they no longer have any available credit.
Anyway, that's a few reasons why it’s so important to maintain good credit. I’m sure there are many more consequences for defaulters, so if you know of them, please share them here.
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