What really happens when you default on a business loan
3 consequences — and tips to help you avoid default.
A default occurs when you fail to make your monthly payments. It can seriously affect both your business and personal finances. If your business has defaulted — or is at risk of defaulting — get familiar with the potential consequences.
You could be responsible for repayment
You and your business partners might be required to pay off the loan with your personal funds if you signed a personal guarantee.
How much you have to pay depends on the type of personal guarantee you have. In some cases, you might have to cover the total loan cost and any associated legal fees. Other agreements might cap how much you have to pay or split responsibility between owners based on the percentage of ownership.
What is a personal guarantee?
A personal guarantee means that you’re responsible for repaying your loan if your business can’t. Lenders require this as a form of security — even on unsecured loans — to ensure that they will still be repaid even if your business goes under. There are two types of personal guarantees, so be sure you understand what your financial risk is before you sign any loan documents.
Your personal assets could be seized
Your lender can come after your personal assets if your business is unable to repay its debts.
If your loan is secured and you’re a sole proprietor, a collection agency will likely be able to seize your personal assets along with your business assets to pay back your loan. If you secured your loan with personal property — like your house or car — this can be repossessed as well.
But even if it’s unsecured, your personal assets may still be at risk. Because most lenders require a personal guarantee, lenders can collect against your personal assets. You may also be required to pay additional fees, penalties and the cost of the lawsuit.
Your credit scores can take a hit
Default can be added to both your personal and business credit reports, lowering your scores. If your business is set up as its own distinct legal entity, then your personal credit score will be unaffected — but it will still hurt your business score.
What happens if I default on an SBA loan?
The SBA will guarantee up to 75% to 85% of your business loan. When a lender can’t collect payments, the federal government takes over. The SBA will contact you and request that you either pay the rest of the loan amount or submit an Offer in Compromise within 60 days.
Failing to do either of these can result in the US Treasury Department to get involved. You and your business partners can have your bank accounts, wages and tax refunds garnished until the loan is repaid in full.
What can I do if I can’t repay my loan?
If you aren’t able to repay your business loan, make sure you know two things: The lender’s late payment policy and how it processes default. Check what your lender charges for late payments — and if you default, contact your lender’s customer service to see what steps it will take to collect on past-due accounts.
- Review late payment policies. Most lenders assess a fee or increase your interest rate when you miss a payment. Understand how the lender handles late payments, including the fees it charges and how a default is defined in your loan contract.
- Contact your lender. If you know you won’t be able to make a payment on your business loan, contact your lender as soon as possible. It may be willing to set up an alternate payment plan or adjust your loan to help your business avoid default.
- Contact debt collectors. If your loan has gone to collections, contact your debt collector. You may be able to negotiate for a lower monthly payment, easier repayment schedule or reduce your total amount owed.
- Look into refinancing. It may not be easy if your business is struggling, but refinancing could be beneficial. A new lender may have better repayment terms, lower interest or better policies for late payments. However, it may be difficult to find a lender that will work with your business if you’ve already made late payments or have an account in collections.
Compare providers for refinancing a business loan
Should I file for Chapter 11 Bankruptcy?
Chapter 11 is a flexible bankruptcy option for businesses. And while filing will restructure your debts and potentially eliminate them, it may risk your business’s reputation and working relationships with creditors.
This doesn’t make it a good choice for every business, but it can provide some financial relief if your business is struggling to pay its creditors. Speak with a financial advisor and learn more about Chapter 11 to be sure this is the right decision for your business’s debt.
Defaulting on a business loan isn’t the end of the world, but it can be a tough situation to get out of. And if you haven’t defaulted but may not be able to make payments, refinancing your business loan can help make your debt easier to handle.
Frequently asked questions
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