A small business loan can be a game-changer — it can ease a cash flow crunch, allow you to invest in new equipment, and help you seize new opportunities for your business. However, taking on debt always involves some risk. What happens if your company hits a road bump and you miss one, two, or more loan payments?
The consequence of missing a loan payment depends on how the loan is structured, how your business is structured, and whether or not you put up collateral or signed a personal guarantee for the loan. Here’s what you need to know about what happens to a loan if a business fails to keep up its payments.
Key Points
• Business loan default is defined as missing several loan payments over a period of time, typically determined by your lender.
• Defaulting on a business loan can result in severe consequences, including legal action from the lender, seizure of collateral, and damage to the business’s and owner’s credit ratings.
• A default negatively affects the credit scores of both the business and its owner, making it more difficult to secure future financing and potentially leading to higher interest rates on future loans.
• To avoid default, businesses should communicate with lenders at the first sign of trouble and explore options like loan restructuring or refinancing to manage debt more effectively.
What Does It Mean to Default?
A single late or missed payment is typically defined as loan delinquency. A loan in default, on the other hand, is often defined as missing several payments over a period of time. However, whether your small business loan is considered delinquent or in default depends entirely on your specific lender and the lender’s policy.
What Does It Mean to Be Delinquent?
Being delinquent on a small business loan means that the borrower has failed to make one or more scheduled payments by their due dates. Delinquency typically begins the day after a missed payment and can have serious consequences if not addressed promptly.
Fortunately, missing one payment shouldn’t result in too many repercussions. You may have to pay a late fee on your next payment, and you may receive a call from your lender asking you why you missed your last payment. If you just simply forgot, tell them and make the payment. However, if you’re unable to make a payment, explain the situation to them. They may be able to help you, whether that means allowing for partial payment, extending your due date, or even pausing your payments until your business is back on track.
If you miss many payments, however, your small business loan is at risk of going into default. To find out exactly when your lender considers your loan to be in default, look at your loan terms or reach out and ask them about their policy.
Once your business loan is in default, the lender will certainly reach out to you. They’ll want to know why you’ve missed payments, and, in some cases, they’ll offer assistance or adjustments in terms that could help you more realistically reach your payments. If they don’t offer you anything, try to give them a timeline of when they can expect to start receiving payments again.
By working with your lender, you can hopefully bounce back from a couple of missed payments and get back on the repayment track.
The biggest consequence of several missed payments is that your business credit score will likely take a hit. The reason is that most lenders report defaults to the various credit reporting bureaus. This could make it harder (and more expensive) to take out a business loan or get a business credit card in the future.
Depending on how your business is structured, defaulting on a business loan can affect personal credit, as well. Some structures, such as a limited liability company (LLC) offer liability protection to owners. Sole proprietorships, on the other hand, leave the owner personally responsible for business debts.
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What Are Some Options If You Can’t Pay Back a Loan?
Hopefully, you can recover quickly from a missed loan payment or two without too much damage to your credit score or funds lost on late payment penalty fees. But what if your company’s financial problems continue and there is no way it can repay the business loan in full?
The best solution is to speak with your lender. Your lender may allow you to defer payments, make interest only payments, or even renegotiate the loan terms to help your business avoid default. If your lender doesn’t offer you any options, you might consider refinancing the loan, seeking the help of outside investors, or crowdfunding to raise money for repaying the loan.
If, worst case scenario, you’re on the verge of business failure, you may want to consider filing for business bankruptcy. Some debts can be discharged through bankruptcy, but not all of them. For more information, speak with a lawyer to weigh the pros and cons.
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What Happens If You Default on a Business Loan?
While lenders will typically do their best to work with you, continued missed payments will result in more aggressive collection practices from your lender.
After a certain amount of time (how long will depend on the lender), your business loan will be considered a “charge off,” which means the lender doesn’t expect that you’ll ever pay your business loan back. The lender will then take measures to recoup their losses incurred by your loan default.
Exactly what that looks like will depend on the circumstances of your loan. Here are four different types of business loans and what defaulting on each may look like:
Secured Business Loan
If you have a secured business loan, that means your loan is secured by some sort of collateral, such as a vehicle, business equipment, or savings account. The lender will take possession of the asset to recoup their losses.
Unsecured Business Loan
If you did not secure the loan with any assets, you have an unsecured business loan and your lender will likely sue your business to collect on the loan. In this case, they are allowed to seek compensation not only for the outstanding balance of the loan, but also for interest, penalties, and fees. Alternatively, your lender may hand the collection process off to a collection agency, who will take legal steps to recoup the debt and fees in place of the lender.
Business Loan With a Personal Guarantee
If you signed a personal guarantee for your unsecured loan, the stakes can be higher. Typically, a personal guarantee doesn’t involve putting up one particular asset but, rather, gives a lender the right to seize any personal assets (including cash and property) until they’ve made their money back.
SBA Loan
If you have an SBA loan, the process will look a bit different. At first, the lender who funded the loan will begin the collection process and take possession of any collateral attached to the loan.
They will then submit a claim to the SBA, who will pay the lender the portion of the loan they guaranteed. The SBA will then contact you and request payment to cover their expenses. You can then resolve the situation by paying what you owe or negotiating with them so that they accept a smaller payment. If you and the SBA don’t find a resolution, however, the government could garnish your wages.
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Tips for Recovering From Business Loan Defaults
Even if you are able to negotiate with your lender and resume your loan payments, a loan default will have a negative impact on your business and/or personal credit. How can you recover?
To build back your credit profile, you’ll want to make sure you make all future payments to creditors on time. It can also be helpful to use your personal and business credit cards for various expenses and then pay them off fully and on time every month. Little by little, you will be able to add positive information to your credit reports and reduce the impact of the default.
To make sure you don’t default on loan payments again, it can be a good idea to look closely at your business’s monthly cash flow and see if you can find any ways to trim expenses. You may also want to hire a CPA to take a close look at your company’s finances. Another option is to bring in an angel investor who understands your industry. You will lose some equity, but their input and expertise may be able to turn your business around.
The Takeaway
One missed or late loan payment won’t likely result in any serious consequences, but two or more missed payments may be considered a loan default, which can impact your credit and put your business and personal assets at risk.
If you know you won’t be able to make a payment on your business loan, it’s a good idea to contact your lender right away. They may be willing to set up an alternate payment plan or adjust your loan to help your business avoid default.
One way to reduce the risk of defaulting on business debt is to find a loan that fits both your needs and your budget.
If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
FAQ
Can you get out of business loans?
Typically, no. But if you’re up front with your lender about your business’s financial difficulties, they may be willing to work with you and make your repayments easier to manage. In some cases, eligible debts may be written off if you file for bankruptcy.
Why is defaulting on loans bad?
A loan default will negatively affect your credit scores. It can also put your professional and personal assets at risk.
Photo credit: iStock/designer491
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