What Happens When You Take Out a Loan and Don't Use It?

Life moves fast, and that sometimes means changing course.

For example, let's say you decide to finish your basement and take out a personal loan to pay for the project. Before the first wall stud is hung, though, your company transfers you halfway across the country. Since the return on investment (ROI) for a finished basement in your area is only around 70%, you decide to scrap the job and focus on getting the rest of the house ready to sell.

The problem is, the personal loan lender has already deposited the funds in your checking account. So, what are your options?

Return the money?

Once loan proceeds have been deposited into your account (or a check delivered into your hands), there's no real way to give it back. From the moment you sign loan papers, you're a borrower. As such, you're on the hook to respect the terms of the loan, including the repayment plan.

Origination fee

The loan provider might have charged you an origination fee for the work they put into the loan, including running your credit history. To make sure you could afford the monthly payment, they spent time comparing your monthly income to your financial obligations, such as:

• Mortgage
• Car loan
• Credit card debt

The personal loan lender also went over your loan options, including the proposed interest rate, repayment term, and any extra fees they charge. While all this happened before you signed a loan agreement, once you sign loan papers, you own the loan.

From checking your credit score to reviewing your repayment options, a lender views time spent on your loan as work, and most want to be repaid for their time. That helps explain the origination fee charged by some lenders. Whether you borrowed money from an online lender, bank, or credit union, it's important to know whether or not they charge an origination fee.

Let's say you borrowed $50,000 from an online lender that charges a 5% origination fee. The first thing most do is take that origination fee out of your proceeds. So rather than deposit the full $50,000 in your bank account, they deposit $47,500 ($50,000 - $2,500 fee = $47,500).

The tricky bit here is that you must repay the entire $50,000, not just the $47,500 that hit your bank account. Even if you decide to repay the loan in full the day after taking it out, you'll owe $50,000.

Prepayment penalty

While the best personal loan lenders do not charge a prepayment penalty, many do. No matter what kind of loan you opted for, the lender counted on earning a specific amount of interest through receiving payments as agreed. Paying off a loan early means the lender loses out on interest payments. To make up for the loss, some lenders charge a prepayment penalty. It may be factored in one of three ways:

• A flat fee
• A percentage of the loan balance
• The interest the lender will miss out on because you paid off the loan early

Let's say the lender in this case charges a prepayment penalty of 1.5% of the loan balance. That would tack an extra $750 onto your total due ($50,000 x 1.5% = $750). Now, paying the lender back in full will cost $50,750, or $3,250 more than the lender initially deposited into your account.

Spend the money?

The fact that the unused loan is going to end up costing you more than $3,000 may be enough to tempt you to spend the funds or take them with you when you move. And that's fine -- as long as you keep up with the monthly payments as agreed.

If it's an unsecured personal loan (meaning no collateral was involved), most lenders don't care what you do with the funds. However, a debt consolidation loan is an exception, because it was granted for a specific purpose. If the lender never asked about your purpose for borrowing money, you should be able to use it in whatever way you choose.

But again, that's only if you make every monthly payment as agreed. Depending on the details of your loan, failure to pay comes with its own set of consequences. For example:

If you took out an unsecured loan

The most common type of personal loan is unsecured. That means the lender allowed you to borrow money with nothing more than your signature as a guarantee that the loan would be repaid. If you fail to live up to your end of the agreement, it will be reported to the credit bureau and your credit score is likely to take a nosedive. The problem with allowing your credit score to be damaged is that it can take years to rebuild your credit history. In the meantime, bad credit means paying more for any other loans for which you might apply. Bad credit can also make it harder to rent a place to live, secure auto insurance, or even land the job that you want.

If you took out a secured loan

A secured loan requires that you put something of value up as collateral to protect the lender if you stop making payments. What makes a secured personal loan attractive is that it typically carries a lower interest rate than an unsecured loan. That's because if you stop making the monthly loan payment, the lender can repossess the collateral, sell it, and recoup their losses.

For example, if you took out a loan for $50,000 using a rare classic car as collateral, the lender has a right to that car once you miss payments. No matter where you move, you must honor the terms of the loan agreement or risk losing the collateral. And you can be sure that no matter where you move, the lender can find you (and their collateral).

If you had a cosigner on your loan

If, for any reason, you needed a cosigner to qualify for the loan, the cosigner will be on the hook for the money if you stop paying. Not only will your credit score sink, but your cosigner will be legally responsible for taking over the debt. Unless they pay the loan, their credit score will also drop, making future loans more difficult for them to land.

Two legitimate options

If you decide that you don't want or need a loan once you have received the funds, you have two options:

1. Take the financial hit and repay the loan, along with origination fees and prepayment penalty.
2. Use the money for another purpose, but faithfully make each monthly payment until the loan is paid in full.

The good news

The higher your credit score, the more options you have regarding loans of all kinds. In fact, if you have an excellent credit score, you can probably land a personal loan without an origination fee or prepayment penalty. That's because you're the kind of borrower a lender would like to see sign up for another loan.

If your credit score is not quite where it should be, take steps to raise it to a level that makes you an extremely attractive borrower. It may take some time and effort, but the payoff is more than worth the trouble.