What happens if you default on a loan?

Every entrepreneur who borrows money has high hopes that they’ll be able to repay the loan and come out stronger on the other end. Every day, the American Dream is fueled in this way across the nation.

But what happens when you default on a loan? It’s an important question because the volatility of the small business world makes it impossible to predict the future.

If you were to default on your small business loan, the outcome would depend on how you guaranteed that loan. Here are 3 common scenarios:

1. Secured loan: If you obtained a secured loan, you were likely required at the onset to provide collateral. Common forms of collateral include vehicles, homes, real estate, machinery, inventory, or accounts receivable.

If you were to default on your secured loan, the outcome would already be laid out. Because you’d be unable to continue to pay back the money you owed, the lender would be able to take possession of whatever collateral you used to guarantee the loan.

1. Secured SBA loan: If you default on an SBA loan, the lender will begin the collection process as spelled out in your SBA loan agreement. And they will likely take possession of the assets you used to collateralize your loan.

Once the lender has exhausted their options for recovering the outstanding balance, they’ll file a claim with the SBA. The agency would then pay out the guaranteed amount.

At this point, the lender would turn your debt over to the SBA and they would request payment. You’d have the option of making an offer in compromise, which is where you plead your case and ask them to accept a lower amount.

If this stage fails to resolve the issue, the SBA would send your account to the Treasury Department for collections.

1. Unsecured loan: These loans are unique because you aren’t required to guarantee the loan with collateral. TThe lender’s risk is greater, which makes it hard to qualify for unsecured loans. Additionally, the amounts are smaller, interest rates are higher, and repayment terms are less favorable for borrowers.

In many cases, a lender will still require a personal guarantee if you’re seeking an unsecured loan. So while you won’t need to offer up your home as collateral, you’ll still accept personal responsibility for the loan. If you’re unable to repay it, the lender will have the option to come after your personal assets.

Regardless of which route you choose for your small business financing, it’s important to remember that you should communicate with your lender. If you’re worried about your ability to make a monthly payment, let them know your situation and that you want to find a solution.

As a rule of thumb, you should always reach out to your lender before they pick up the phone and call you. In most cases, your lender will work with you to find a solution, as they have no interest in watching the loan go into default. By making the loan a true partnership and keeping the communication channels open, you’ll help make the whole experience better for everyone.