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What Happens When I Default on a Business Loan?

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What Happens When I Default on a Business Loan?

Published: August 19, 2010 Updated: June 17, 2011

Note: The ARRA (Recovery Act) initiatives and/or programs referenced in this article will expire on September 30, 2010. Any statements about qualifying time periods, or extensions of these dates, as they pertain to the availability of ARRA programs are over-ridden by the expiration of the Act on September 30, 2010.


 

What does it mean to default on a loan?

A loan default is the failure to meet the financial obligations indicated in the loan agreement that is signed by you and your lender. Often, a loan default translates into the business owner's inability to pay their debts on time. Due to the differences in each loan agreement, default penalties vary. However, the effects of defaulting on the loan fall into two general categories: immediate repercussions and future implications for both you and your business.

What are the immediate effects to my business if I default on a loan?

Drop in business and/or personal credit score. Missing your payments and defaulting on your loans negatively impacts your business credit score. Your personal credit score may be affected, depending on the type of business structure that you have in place. Read on for more tips on how to protect your personal liability.

Increased interest rates. Your business interest rates (and possibly your personal interest rates) may increase if your credit score dips. Depending on your loan agreement, a higher interest rate could affect the loans that you currently have, as well as future loans you plan to seek.

Foreclosure or seizing of property and collateral. Foreclosure may be the most severe repercussion due to a loan default, allowing lenders to recuperate losses from loan defaults. In this situation, your lender will have the full right to take control and ownership of your property and collateral that you have included in your contract. They normally will sell your property privately or by a public auction, depending on the profit margin.

What steps should I take next?

Negotiate terms with your lender. If you default, you can try renegotiating the terms of your loan contract with your lender. While lenders may not always be willing to renegotiate, if you are successful you can minimize the damage to your business's financial health. Ways to reduce the negative impacts of the loan default include:

  • Changing the terms of payment e.g. paying less per installment but for a longer period of time
  • Paying less over more time with a higher interest
  • Asking your lender to forgive a portion of your late payment and agree to pay on time in the future

Consider government debt relief options. There are some government-backed options for managing debt that you can consider, such as the American Recovery and Reinvestment Act (ARRA), ARC Loan Program. and SBA Loan Program. Read more about Managing Small Business Debt through Government Loans and Refinancing Lifelines here.

Cut costs. Minimize your expenses. Though this may not be an ideal situation, you can consider laying off part of your staff and downsizing your business, among others.

Sell business assets. Liquidating business assets or converting your assets into cash may temporarily help you pay off your loans until you can afford to pay your bills on time again.

Consult a lawyer. Consulting a lawyer about your options may also help you through the process. Learn how to find legal representation for your small business here.

What does this mean for the future of my business?

Difficulty finding new loans. After you default on one loan, it will make it much more difficult to find a new loan. If loans are the chief means of financing your business, then you will be running into some difficult hurdles. You may want to start looking into other methods of funding your business. Read more about alternative financing solutions in I Need Money- Where Do I Get It?

Bankruptcy. If your business cannot repay its loans, you may need to file for bankruptcy. Read more about filing for bankruptcy our blog on Bankruptcy Options for Small Business Owners.

What Can I Do to Avoid a Loan Default?

Of course, the best way to avoid defaulting is to pinpoint the pitfalls of bad loans and avoid them at all costs. To avoid loan defaults, business owners should remember the following best practices:

  • Have a concrete payment plan before you decide to borrow
  • Do not offer collateral and property in your contract that you cannot afford to lose
  • Read the fine print and thoroughly understand the terms of contract

Related Resources

The Fine Print: Business Loan Terms

I'm Applying for a Loan. How Do I Know if I Have Enough Collateral?

Bankruptcy Options for the Small Business Owner

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Comments:

I clicked on the "Learn how to find legal representation for your small business here" link above but it sent me to a page of blogs. I'm still seeking advice on how to find appropriate legal rep. in the relevant state. Thanks.
Update to previous comments: the SBA is becoming more picky with regards to settlements. When the economy was bad, people had few ways to raise cash, and prospects of future income seemed bleak. As things are improving, the SBA is increasingly negotiating harder and harder. While settlements are still possible, it makes more sense than ever to have a seasoned SBA workout professional on your side. Be sure to use an expert who knows SBA inside and out...not all workout consultants are created equal.
Luckily the SBA loan default rate is under 2% right now. This is way down from the highs set after the financial crisis. Good thing for small business in America. Probably not too many borrowers are reading this post right now due to the low default rate, but for those that do, there are definitely other options out there that are not mentioned in this article. Jason did mention above that there is an "offer in compromise" option, which basically means you can settle with the SBA for a fraction of what you owe. Very often our clients settle $500,000 in debt for pennies on the dollar, depending on what your personal asset value looks like. Definitely explore this option with a SBA settlement expert before you chose bankruptcy.
I have 2 comments about this article... 1 - perhaps I missed it but there is no mention of the SBA Offer in Compromise process. If warranted, the SBA will consider settling the loan balance for less than the full balance. Not everyone qualifies, but it's definitely an alternative that every borrower should be aware of. 2. I dispute the notion that you need an attorney in all cases. I get calls all the time from people who were disappointed that their attorney didn't have any SBA workout experience. To sucessfully navigate an SBA workout, you need an advisor who is an expert with regards to the modification and settlement of SBA debt. Many attorneys don't fit that description.
It's also worth mentioning that there are often no credit score impacts because most commercial lenders do not report to the credit bureaus because the individual is typically only the guarantors and not the borrower. To find out if your commercial loan is showing up on your credit, the simple thing to do is get a copy of your credit report.
Thank you, very interesting article! However, I do not fully understand about Business Loan. How they differ from those of a mortgage or loan on the car. If not hard please tell us about it.
Why doesn't the SBA publish failure rates of small businesses up front so "potential future defaulters" know what they are getting into? Is there a place on SBA.gov that gives statistics on how many new, for example, pizza shops failed in Idaho last year? First year failures? Second year failures? Profitability timelines?
Yes, you're right! it's a trouble for both the lender and borrower if the latter doesn't have any concrete payment plans. Charles Baratta ---This post was edited to remove a commercial link. Read our discussion policies for more Community best practices.
Be sure to read through the FTC's web page about managing debt.
Keep in mind that the rules that apply to student loans are not the same as the ones for business loans. If you are trying to adjust the terms of your loan, are looking for loan forgiveness, or are in danger of defaulting on your loan the first step should be discussing it with your lender.

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