A secured debt is one for which a specific item of property—called a security interest or collateral—guarantees payment of the debt. If you don’t pay a debt secured by personal property, the creditor has the right to take the property pledged as collateral for the loan. The creditor can’t just walk into your house and take your couch, however. The creditor must have a court order or permission from someone in your household to enter your home.
Creditors who don’t have a security interest in an item of property can’t take it without approval of a judge or court clerk.
(To learn more about property that is subject to repossession, see Repossession: What Property Creditors Can and Can’t Take.)
What Constitutes a Default?
Unless your contract says otherwise, if you miss even one payment, you have defaulted on your loan and, under most security agreements, the creditor is entitled to take the goods. If you make your payments but otherwise fail to comply with an important term of the security agreement, the creditor can also declare you in default and take the property. Sometimes lenders have the right to declare a secured debt in default, even if you’re all paid up. This may happen in any of the following cases:
- You sell the collateral.
- The collateral is destroyed or stolen, or its value substantially depreciates.
- You let required insurance lapse—some lenders require that you have collision and comprehensive insurance on motor vehicles, or that you buy credit life or credit disability insurance.
- You become insolvent (as defined by your lender).
- You refuse to let the creditor examine the collateral at its request.
- The creditor feels that the prospect of your paying is uncertain.
Be sure to read the security agreement’s fine print carefully to see what is considered a default.
What Happens When You Default
If you default, here’s what might happen before the creditor repossesses the collateral.
Does the Creditor Have to Notify You Before Repossession?
Whether a creditor has to notify you before it takes your property depends on what state you live in and on the terms of your original agreement with the creditor. Generally, unless the contract specifically says otherwise, the creditor must notify you that it has accelerated the debt and that the full contract amount is due. This warning can give you time to figure out a plan. However, in many contracts, you waive the right to receive advance notice. In some cases you can challenge these waiver clauses, but you will likely need the assistance of an attorney to do so.
The Right to Cure the Default
Fortunately for consumers, many states require creditors to notify you of a “right to cure” the default. If you want to take advantage of the “right to cure,” you must do so before the debt is accelerated and the property is repossessed. You get a certain period of time (usually a few weeks) to pay all missed payments and any late charges, get required insurance, or otherwise rectify the situation that caused the default. You will need to research your state law to see if you have a right to cure where you live. (To learn how to research state law, see Nolo’s Legal Research area.)
(For more information, see our comprehensive area on Repossession of Cars and Personal Property.)
Will the Creditor Always Repossess?
A few states prohibit creditors from repossessing property without first getting a court order. But even outside of these states, a creditor is unlikely to go ahead and take your property (except perhaps motor vehicles) unless you have defaulted in the past, have missed several payments, or are uncooperative, or the creditor has learned something worrisome about your finances.
Returning the Property On Your Own
You can voluntarily return the collateral, but the creditor doesn’t have to take it. And he or she probably won’t if it’s worth far less than you owe. If you want to give the property back, first call the creditor—ask to speak to someone in the collections department—and find out whether your entire debt will be canceled when the collateral is returned. If the creditor agrees to cancel the entire debt, get written confirmation. Also find out whether the creditor will refrain from reporting the default on your credit report. If the entire debt isn’t canceled, there probably isn’t much point in returning the item, as you’ll be liable for the difference between what the collateral sells for and what you owe.