You state that as a hypothetical, but it's not like this has never been tried. The loans handled by lenders who include the threat of violence in the repayment plan are absolutely not characterized by low costs.
- You may have no legal recourse and no collateral to seize
- The loan may be funding risky or illegal activity with a high likelihood of failure, which demands a higher interest rate
- There may be no competition that drives the price down
Ceteris paribus, increasing the cost of non-payment should reduce interest rates. If you relax the "ceteris paribus", then all bets are off.
Another way to see this is this question: if the lender had to forsake the threat of violence, would the loan price go up or down?
I apologize that my example isn't perfect, and you're absolutely right, there is selection bias, unless there is little recourse for other products.