What Happens If You Default on a Business Loan?

Default vs delinquency: Understanding the difference.

Often, the terms ‘default’ and ‘delinquency’ are used interchangeably, but they represent two distinctly different stages of loan repayment trouble. Delinquency refers to missing a single scheduled payment. It’s a bit like stumbling, but you still have a chance to regain your balance. You usually have a grace period to make up the missed payment before the lender takes further action.

On the other hand, default is when multiple payments have been missed, typically over a period of 90 to 180 days. This is equivalent to falling flat on your face. At this stage, the lender assumes that the borrower is unable or unwilling to meet the loan obligations and may take legal action to recover the owed money.

So what happens if you default? That depends, as the consequences of business loan default vary depending on how you guaranteed the financing. Let’s look at three possibilities:

1. Unsecured loans 

This type of loan doesn’t require any type of collateral from the borrower in order to secure the funds (hence the name). Lenders are understandably reluctant to offer these loans as they involve higher risk. To compensate for this lack of collateral, unsecured loans usually have lower dollar amounts, higher interest rates, and shorter repayment terms.

Additionally, lenders usually require you to make a personal guarantee to receive an unsecured loan. While this isn’t technically collateral, there’s a similar impact if you default on an unsecured loan. The lender will come after your personal assets to recoup the money involved with the financing.

2. Secured loans 

While unsecured loans often need a personal guarantee, lenders take it to a more specific level with secured loans—you’ll be asked to provide collateral that meets or exceeds the value of the loan. Popular examples of collateral include homes, boats, vehicles, real estate, inventory, machinery, and accounts receivables.

In the case of a default, some lenders may be willing to work with you to find a solution. But if you’re ultimately unable to meet your payment obligations, the promised collateral will become the property of the lender. The lender will need to put time and effort into selling the asset before they actually get paid, which is why collateral must often be worth more than the actual value of the loan.

3. Secured SBA loans 

If you default on a SBA loan, your first interactions will be with the lender who funded the loan. They’ll begin the collection process outlined in the loan agreement, which usually includes the lender taking possession of any collateral attached to the loan.

At this point, the lender submits a claim to the SBA. Because the agency will have guaranteed a portion of your loan, they’ll pay the lender that amount.

The remaining debt is then transferred to the SBA. The agency will request payment from you to cover their expenses. If you’re financially able, you can resolve the situation immediately. You can also make an offer in compromise, where you explain any extenuating circumstances and request that the SBA let you settle the debt with a smaller payment than is officially required.

Assuming the SBA accepts your payment or offer, the case will be closed. When a resolution can’t be found, however, the agency submits your account to collections officials at the Treasury Department. This phase is where things can get serious, as the Treasury Department has the authority to garnish wages and take other actions to get the money they are owed.

Additional impacts of a business loan default.

The simple act of missing loan payments hurts your business credit score, so a default makes an even more substantial impact. Lenders will likely regard you as a higher risk in the future, leading to higher interest rates and shorter repayment terms on future financing.

Your personal credit score might also be affected, depending on how you set up your business. Some structures offer liability protection to owners. For example, a limited liability company (LLC) provides shelter from defaults. Sole proprietorships, on the other hand, leave the owner completely responsible for such failures.

While no small business owner ever applies for financing with the intent of defaulting, it’s wise to consider that possibility as you set up your business. Your strategy at the onset can potentially save a lot of headaches and financial losses down the road.

Avoiding default on a business loan: strategies to consider.

Avoiding a default on a business loan requires proactive planning, regular financial monitoring, and prudent business management. Here are some strategies you may want to consider:

1. Improve your cash flow – Financial health of a business largely depends upon its cash flow. Implement strategies to improve cash flow like prompt invoicing, offering discounts for quick payments, and managing inventory efficiently.
2. Regularly monitor your finances – Keep a close eye on your cash flow and financial forecasts. Regular monitoring will help you identify potential issues before they become serious problems.
3. Maintain good relations with your lender – Maintain open lines of communication with your lender. If you foresee any financial hiccups, inform your lender in advance. They may work with you to adjust the payment terms.
4. Consider loan refinancing – If your current loan repayments are becoming difficult to manage, loan refinancing might be an option. It could help you secure lower monthly payments, but be aware that this could mean you’ll be paying more in total over a longer period of time.
5. Seek financial advice – If you’re struggling to manage your business finances, seek advice from a financial advisor. They can assist you in reviewing your financial situation and suggest ways to manage your debts effectively.

Remember, business financial management requires consistent attention and action. By adopting these strategies, you can significantly reduce the risk of defaulting on your loan.

What to do after your loan goes into default.

If your business loan has already gone into default, don’t panic. There are still steps you can take to mitigate the situation:

1. Communicate with your lender – Reach out to your lender immediately. Transparency about your financial situation can lead to a cooperative and understanding approach from the lender. They may provide options for loan restructuring or deferment.
2. Consult a financial advisor – This is a critical step. A financial advisor can guide you on how to navigate this predicament. They may suggest ways to consolidate your debt or advise on possible legal implications.
3. Evaluate your financial situation – Take a hard look at your finances with the goal of freeing up resources to repay your debt. Identify areas where you can cut costs and increase revenue. 
4. Consider selling assets – If you have assets that you don’t need and can easily liquidate, consider selling them to pay off your debt.
5. Negotiate with the lender – If your financial situation is dire and there’s no way you can pay back the loan in the near future, consider negotiating with the lender. They may agree to reduce the debt or modify the terms to fit your current ability to repay.
6. Explore legal options – If negotiations fail or aren’t an option, you might want to explore legal options like bankruptcy. However, this should be your last resort, as it would severely impact your credit score and reputation. Always consult with a legal advisor before choosing this path.

Remember, defaulting on a loan is serious, but not the end of the world. There are always options available to get your business back on track.