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 seriously effect both your business and your personal credit, and you may find yourself stuck paying for the consequences out of your own pocket — including interest charges, higher interest rates for future loans, and possibly being rejected for loans in the future.
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 it’s a secured loan 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 your car — this can be repossessed as well.
If it’s an unsecured loan and 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 a Canadian-Controlled Private Corporation (CCPC) or a public corporation. You may also be required to pay additional fees, penalties and the cost of the lawsuit.
Your credit scores can take a hit
When you default on a business loan, it can lower both your personal and business credit scores if the loan was personally guaranteed or if you were a sole proprietor. 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 one.
Defaulting on a CSBFP loan
Canada Small Business Financing Program (CSBFP) Loans are funded by banks but are at least 75% guaranteed by the federal government. You may be required to provide a personal guarantee to qualify for this loan, but it must be unsecured and cannot exceed 25% of the loan amount. For corporate CSBFP loans, banks may require either secured or unsecured corporate guarantees up to any amount.
If you’re having trouble repaying the loan and cannot agree with the lender on a way to keep making payments, the lender will provide you with a Notice of Default containing instructions or conditions that must be fulfilled by a certain time. If you don’t follow these instructions, the lender will simply demand repayment by a particular date. If the loan remains unpaid, the lender will seize your business assets and cash in on any personal or corporate guarantees you provided beforehand.
Because banks provide the funds for these loans, they handle the collection and settlement processes, not the government. However, the government mandates that banks follow all the steps that would normally be taken to protect business interests, thus ensuring that the government only repays its guaranteed portion of the loan whenever it’s absolutely necessary.
Banks have up until 60 months after your last payment on the loan to file a claim with the government for repayment.
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 your business loan 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.
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. Read our guide to business loans to learn more about staying ahead of payments.
Frequently asked questions
Yes. Lenders and debt collectors can sue your business to collect outstanding loan balances. If successful, the lender can garnish your bank accounts, place a lien on vehicles or real estate owned by your business or, if you agreed to be personally responsible for the loan, collect against your personal assets.
Delinquency occurs after a late or missed payment. Depending on your loan contract, this may or may not result in default. Some lenders consider default after one delinquent payment, while others may allow multiple delinquent payments before declaring a loan to be in default.
Your lender really doesn’t want to see you default any more than you do, no matter what kind of loan you have. Initiating legal proceedings, hiring a third-party debt collector and seizing assets is neither cheap nor 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. Lenders typically prefer to offer you an extension or adjust your repayment schedule than initiate default proceedings.
Elizabeth Barry is Finder's global fintech editor. She has written about finance for over six years and has been featured in a range of publications and media including Seven News, the ABC, Mamamia, Dynamic Business and Financy. Elizabeth has a Bachelor of Communications and a Master of Creative Writing from the University of Technology Sydney. In 2017, she received the Highly Commended award for Best New Journalist at the IT Journalism Awards. Elizabeth's passion is writing about innovations in financial services (which has surprised her more than anyone else).
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