What Happens When You Default on a Loan (And How to Avoid It)
In most cases, business owners don’t take on loans with the intention of not paying them back. Still, a multitude of circumstances may make repayment difficult — if not impossible — leaving them no choice but to default. According to a recent NerdWallet study, more than one in six SBA-backed loans awarded to small businesses between 2006 and 2015 went into default, meaning the lender deemed them unlikely to be repaid.
If you’re considering a business loan to support or expand your operations, it’s important to know what default means and how it can impact you and your company. Fortunately, there are steps you can take to reduce the likelihood of default before even applying for a business loan.
Here’s What Happens When You Default on a Loan (And How You Can Avoid It):
What Does it Mean to Default on a Loan?
Lenders have different standards for what they consider late payments versus default. According to Equifax, one of the major credit bureaus, a payment is late if it’s made between 14 and 60 days after its due date. A loan is typically considered in default when a payment is more than 60 days late.
What Happens When You Default?
If you fail to make your missed payment, the lender may engage a collections agency to get you to pay. They’ll also report the missed payment to the major credit bureaus. Late payments are damaging to your credit score and can remain on your credit report for up to seven years —even if you repay the debt in that time frame—making it difficult to obtain outside financing until the black mark is removed.
The lender’s recourse also depends on whether your business loan is secured or unsecured.
- With a secured loan, the lender can seize your collateral to repay the debt. Depending on the asset you used to secure the loan, defaulting can impact your personal life as much as it can affect your business. For example, if you secured the loan with your home, your family may end up without a place to live.
- An unsecured loan is different in that the lender can’t seize your assets to satisfy the debt. However, they’ll likely charge you late fees and may increase your interest rate, depending on the terms of the loan. Once they determine you’re unable to repay the loan, they can sue your company for the remaining principal and interest you owe.
Finally, if you backed your loan with a personal guarantee, the lender can sue you personally for the amount you owe. If a court rules against you, you may have to liquidate personal assets to repay the loan.
How to Avoid Default
Put simply, don’t bite off more than you can chew. Make sure you understand your business’s financials and your ability to make the required payments on time. If the monthly payments seem like a stretch, consider borrowing a lesser amount until your cash flow becomes more predictable.
If you have a business loan and find yourself unable to make a payment on time, it’s usually a good idea to let the lender know as soon as possible. If you’re able to convey that you’re experiencing a temporary cash flow shortage rather than permanently defaulting on the loan, the lender may be more willing to work with you. It’s typically in both parties’ best interests to avoid collections — or worse, court.
A business loan can be a great way to get your business off the ground or support its growth. Depending on the type of loan you have, missing payments can have both personal and professional ramifications. To avoid long-term damage to your credit, make sure to do your homework before deciding on the financing solution that’s best for your business.
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