When you're making a relatively small purchase, you might consider paying for it with a personal loan. Borrowers use these loans to buy vacations, technology or home improvement items, or to consolidate debt or pay unexpected expenses. Unlike mortgages, unsecured personal loans are not backed by collateral such as your home. The lender is relying on your promise to make the payments — and stands a high chance of losing money if you default on the loan.
Unsecured Loans are Risky for the Lender
High-dollar loans like mortgages almost invariably are secured loans. Secured loans are supported by collateral such as a property. If you default, the bank can seize the collateral, sell it and use the proceeds to pay the outstanding balance. Unsecured loans have no collateral to back up the loan. This creates a much larger risk for the lender. Lenders mitigate that risk with tougher qualifying criteria and higher interest rates. Borrowers with bad credit will often have a hard time getting an unsecured loan.
Fair Debt Collection Laws
If you default, an unsecured lender has to get a court order against you for the past-due payments. The bank cannot just take money out of your account or send the repo man around to claim your flat-screen television. Typically, a lender will try to collect the debt for several months before turning it over to an attorney or a collection agency. Debt collectors have a legal duty to act honorably per the federal Fair Debt Collection Practices Act, which prohibits collection agencies from misleading, abusing or harassing a debtor. For example, a debt collector cannot call you repeatedly or threaten to seize your possessions. States may have their own, tougher rules.
Laws for Garnishing Wages
Once the lender has a judgment, it has to determine a way to collect the debt. The most common debt-collection method is an order for "garnishment," which permits the lender to take the debt directly from your wages or bank account. By law, lenders cannot garnish more than 25 percent of your net paycheck, and they cannot leave you with a weekly income less than 30 times the federal minimum wage. Some states have lower limits. Social Security checks, unemployment benefits, disability benefits, retirement plan proceeds and workers' compensation awards are all protected from garnishment. Pennsylvania, South Carolina and Texas do not permit garnishments at all.
Laws on Seizing Property to Pay an Unsecured Debt
Another option is for the lender to get a court order permitting the sheriff to visit your home and take any cash he finds there up to the amount of the judgment. The court might also authorize a sheriff to take jewelry, art, technology or some other property that is worth more than what you owe. The law here is that the sheriff cannot touch "exempt property" — a list of personal possessions that you're permitted to keep, no matter how much the debt. The list varies by state but generally, it includes food, furniture, clothing, pets, medical equipment and one vehicle up to a certain value — say, $3,000.
There's a Statute of Limitations
All states have a statute of limitations for collecting personal loans. If the lender hasn't been to court and won a judgment by the end of the limitation period, the debt becomes legally uncollectible. In most states, the statute of limitations is about six years. Louisiana, Kentucky, Rhode Island and Ohio have longer limitation periods at 10 years.