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What really happens when you default on a business loan

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Worried about not paying back a business loan? Here’s what could happen if you default.

Even the best plans can go astray, leaving you with debt against your business that you can’t afford to repay. A default occurs when you fail to make your monthly payments. This can leave a black mark on both your business and your personal credit, and you may find yourself stuck paying for the consequences out of your own pocket.

What happens when I default on a business loan?

When a loan goes into default, the lender attempts to collect on the full debt your business owes. Their options depend on the type of loan you borrowed.

  • Secured loans. Many loans require you to put up collateral should you default. If you do, your lender can repossess it to recover its investment.
  • Unsecured loans. Loans without collateral may be turned over to debt collection agency that attempt to collect on the lender’s behalf. This may lead to wage garnishing and the seizing of your personal assets.

Will a lender come after my personal assets?

It depends on the type of loan your borrowed and how your business is set up.

If you’re a sole proprietor, then yes, 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 your car — this can be repossessed as well.

If you’re incorporated, the process becomes more difficult for the collection agency unless you signed a personal guarantee. This allows lenders to collect against your personal assets, even if your business is structured as an LLC or a corporation. You may also be required to pay additional fees, penalties and the cost of the lawsuit.

Defaulting on an SBA loan

An Small Business Administration loan is a business loan that’s guaranteed by the federal government. Because the federal government guarantees 75% to 85% of your loan, when the 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 does a default mean for my credit history?

Defaulting on a loan has significant long-term financial impacts that can make it hard to qualify for a loan down the road. If you’re having a tough time paying your loan and think you might default, contact the lender, quickly. Your lender has to submit an official report for the default to be registered, so you may be able to work something out before they submit. It’s likely they’ll work with you by offering a payment plan or put a hold on your loan until your business is back on track, avoiding a hit to your credit score.

When you default on a business loan, it won’t appear against your credit unless the loan was personally guaranteed or if your personal finances were otherwise closely involved, like with a sole proprietorship. If your business is set up as its own distinct legal entity, it may have its own credit report separate from your personal one.

What can I do if I can’t repay my loan?

Before you take out a loan, make sure you know two things:

  • The lender’s procedures for late payments. Understand how the lender handles late payments, including the fees it charges, and how a default is defined in your loan contract.
  • How the lender recovers its money. The process depends on whether you’ve borrowed a secured or unsecured loan, if you’ve made a personal guarantee and how your business is set up.

Before you take on a business loan, it’s best to have a plan in place to make repayments — and to know what your lender expects of you if you can’t. Your lender doesn’t want to see you default any more than you do. Lenders stand to lose money if you can’t repay so this gives them incentive to waive fees or be lenient with payments.

Initiating legal proceedings, hiring a third-party debt collector and seizing assets isn’t cheap or easy, so it’s usually only done as a last resort. The lender knows that even bumping up your fees or interest rates can make it harder for you to repay the loan. Almost all lenders would prefer to offer you an extension or adjust your repayment schedule than initiate default proceedings.

Call or visit your lender

You may have already been contacted by your lender, informing you that you are in default or behind on repayments. Rather than avoid the calls, keep in contact and stay open about your financial situation. This may make your lender more amicable to repayment plans or debt settlements.

It’s best to inform your lender of your inability to pay before your business loan defaults. This way, you can negotiate a plan that benefits both parties and your lender won’t have to initiate complicated recovery procedures.

When you contact your lender, it could:

  • Work with you to adjust your borrowing arrangements and repayment schedule to find a plan that suits your budget.
  • Discuss your business, ask to speak with your accountant and help you make plans to improve cash flow or profits.
  • Recommend a specific financial advisor who can help you or put you in touch with an independent third-party that might be able to help.

Refinance your business loan

Refinancing your loan isn’t always the right thing to do, but if you’re unable to meet your monthly payments due to high interest rates, refinancing could be beneficial.

The process is rather simple. You apply for a new business loan and use the funds you receive to pay off your previous loan. At this point, you’re responsible for making payments to your new lender. However, you should be sure this is the correct course of action by considering these points:

  • Calculate exactly how much your business will save by refinancing the loan.
  • Factor in the origination fees for your new loan and the closing fees of your old loan.

Consider other factors as well, such as whether you’re refinancing to into a secured or unsecured loan and whether you’re supplying a personal guarantee on the new loan. While it may make your rates better, secured loans with personal guarantees can make your situation riskier should your business be close to default again.

If you already have a loan with good terms, then it’s possible that you simply won’t be able to find a refinancing option that’s better than what you have.

Bottom line

Default isn’t the end of the world, but it can be a tough situation to get out of. By contacting your lender and negotiating, you could avoid expensive fees and the loss of your assets. However, the best defense against default is staying ahead of your payments and knowing the terms of your loan.

Frequently asked questions

Elizabeth Barry

Elizabeth is an editor for finder.com.au specialising in personal finance and fintech. She enjoys reading PDSs so you don’t have to.

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