What it Means to Default on a Business Loan & What to do Next

What it Means to Default on a Business Loan & What to do Next

When the loan is in default, the lender can take legal action against the borrower or accelerate the remaining balance. The debtor's credit history will be affected. Default occurs when a borrower breaches the term of their loan agreement. The most common reason for loan default is that the borrower cannot repay the loan.

When you get a small business loan, you have the best intentions of repaying the loan on time and in full. But sometimes, things don't go as planned. If your business is in a temporary recession, you may have difficulty repaying your loan.

This puts you at risk of default, can affect your credit history, and have other serious consequences. You must manage this situation in the best possible way to protect yourself and your future access to capital. However, the details vary by lender, loan type, and loan agreement. Here are some general guidelines on what to expect in the event of a default and how to avoid it in the first place.


What is the Loan Default Rate?

The Federal Reserve keeps data on default rates for different types of loans. Default rates on commercial loans are generally lower than on consumer loans because creditors have higher qualification standards for commercial loans. Default is more common on credit cards, with an average default rate of 2.54%.

Federal Reserve data includes only bank loans. Online business loans from alternate lenders tend to have lower qualification standards. As a result, these loans generally have higher default rates.


What happens when there is a default on a loan?

The circumstances that trigger a default vary by lender and type of loan. Some creditors consider late payments as arrears. However, most people wait until you've missed multiple payments, you don't have enough funds in your bank account to collect the payment, or a payment is at least 30 days past due before they consider your loan to be in default.

Once your loan is in default, your lender will contact you. Over time, your lender will become more aggressive. The borrower's resources vary depending on the details of the loan agreement, but here are the general consequences of defaulting on a loan:

  • Higher Fees: Failure to pay the loan may result in unpaid fees. Also, since your credit score has been affected, any future loans you take out will have higher interest rates.

  • Legal Claims: Your bill may be sent to a collection agency, and you may begin to receive numerous collection calls. At some point, the lender may sue you to collect the debt or repay any collateral you provided in exchange for the loan. Such legal claims can take a lot of time and money.

  • Lower Credit Score: The lender will report any overdue payments to the credit bureaus, which could affect your credit score. The more payments you default, the worse your credit score is. Unpaid payments and fees stay on your credit file for up to seven years.

The details vary depending on the type of loan you have. When you sign the loan agreement, you can include a personal guarantee to repay the loan or provide collateral in exchange for the loan. Let's look at what happens when you take out different types of loans.


Default on a secured loan

A secured loan is one in which loan collateral is placed. Examples include commercial real estate loans and equipment loans. If you don't repay the loan and reach an agreement with the lender, the lender will take possession of the collateral, liquidate it and take the money. In some states, creditors can confiscate collateral without a court order. The creditor must first obtain a court order to seize the collateral in other cases.

Note that most lenders want to avoid foreclosure because it takes time and resources. They prefer to offer a payment plan or another solution.


Default on an unsecured loan

An unsecured loan does not require the placement of specific collateral. Many business loans you can get online are unsecured. However, keep in mind that even if a loan is unsecured, the lender will usually request a personal guarantee from the borrower or place a general guarantee on all business assets.

Once you miss a payment, your lender will usually start charging you for late-payments and may even increase the interest rate on your unsecured loan. If they can't collect the loan, they will likely sue you. Depending on the loan terms, they may obtain money from your company's bank accounts or confiscate your company's assets, such as your company's vehicles, equipment, or real estate domain.


Default on an SBA loan

Here, things can go wrong. Banks provide SBA loans, but a percentage of the loan amount is guaranteed by the US Small Business Administration (SBA), a federal government agency. The federal government will intervene if the bank cannot repay the loan.

First, the bank will try to collect the loan according to the terms of the SBA loan agreement. SBA rules require that most loans be secured by adequate collateral. Next, the lender will start by seizing the business and personal property that has been given as collateral or by a personal guarantee. If this is still not enough to repay the loan, the lender will request the SBA to receive the guaranteed amount from the SBA.

Dealing with the SBA after defaulting on an SBA loan is like dealing with the IRS when you haven't paid your taxes. The SBA will require you to repay the remainder of the loan within 60 days or make an Offer in Compromise, an offer to pay a percentage of what is owed. The SBA then reviews your company's finances to see if it is willing to accept your Offer in Compromise.

Otherwise, the US Treasury Department takes control. The Treasury can collect the balance owing through tax refunds, bank accounts, salaries, and more, as long as it takes to recover the loan.


Steps to help you avoid Loan Default

Because a loan can affect your credit and finances and limit your access to finance in the future, try to avoid getting there. Sometimes there's no alternative to defaulting on a loan, but it's best to keep your options open.

Here are the steps to avoid defaulting on your loan:

  • Consider seeing a debt counselor: If you're struggling with a heavy debt burden, consider meeting with a debt management counselor or credit counselor. They can include you in a debt management plan and provide strategies for paying off your debts.

  • Consult a Bankruptcy Lawyer: Sometimes, bankruptcy isn't far away when a business owner defaults on a loan. Bankruptcy can have even bigger implications for your credit and finances than the default. Please contact an experienced bankruptcy attorney to discuss your options if you consider filing for bankruptcy.

  • Contact the lender immediately: If you have difficulty repaying the loan. The lender can extend the loan term, defer some payments, or work out a payment plan with you. And if you keep a good and open line of communication, the lender is more likely to understand you and avoid collection efforts. Be prepared to answer questions about business and personal income, and be sure to document the terms of any payment plan in writing.

  • Pay what you can: Even if you can't pay the full payment, making smaller micropayments will help you avoid total default. If you make a good faith effort to repay the loan, the lender may be more willing to agree to a payment plan.

When a loan is past due or received, the status will appear on your credit report in one credit cycle (approximately 30 days). If you pay your bill later, the negative signs will not automatically disappear from your credit report. Defaults and collection items can remain on your credit report for up to seven years. Fortunately, their impact diminishes over time, and the lender can withdraw them more quickly as a sign of goodwill.


What to do after a loan default

Bad debt hurts your credit score, makes it difficult to borrow money in the future, and can even bankrupt a business or individual. Before you borrow money, make sure you have a plan for paying it back.

Contact your lender as soon as you discover that you are at risk of defaulting. Lenders hate surprises, and if you're open-minded, many will work with you to help you catch up on late payments and get your account back. And if your loan is in default, you can switch to the other side. Get help from a debt management consultant, cut your expenses, and find ways to ensure you have more control over your finances in the future.



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