What Happens When You Default on a Loan?
Notably, many business owners are pursuing additional financing due to the struggles they’ve faced during the COVID-19 pandemic. During this time, they’re searching for business loans that will enable to keep their operations afloat.
In most cases, small business owners don’t take on loans with the intention of not paying them back. When they sign their contracts, they’re likely confident in their ability to repay their loan while meeting their other financial obligations. Still, a multitude of circumstances may make repayment difficult — if not impossible — leaving them no choice but to default.
According to small business loan default statistics form NerdWallet, more than one in six business owners defaulted on SBA loans between 2006 and 2015, meaning the lender deemed them unlikely to be repaid. It’s evident that defaulting on a business loan is a common issue that business owners face, which is why it’s crucial to avoid it at all costs.
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 small business loan.
In this blog post, we’ll explain how your business can responsibly fulfill your loan obligations, thus avoiding default.
What Is a Business Loan Default?
Lenders have different standards for what they consider late payments versus default. According to Equifax, one of the major credit bureaus, a loan payment is late if it’s made between 14 and 60 days after its due date. A business loan is typically considered in default when a payment is more than 60 days late.
Prior to taking out a business loan, be sure to ask your lender what their late payment policies are. That way, if you have a month in which you’re short on cash flow, you’ll know how long you have until your loan will enter default. This should always be a last resort, and you should account for loan payments in your monthly budget to avoid late payments.
What Happens When You Default On a Business Loan?
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. This makes 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. Many people don’t realize that your business and personal finances can become intertwined in this situation.
- An unsecured loan is different in that the lender can’t seize your personal or business 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 by signing 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.
Regardless of whether you have a secured or unsecured loan, defaulting can cause major financial strain.
How to Avoid Business Loan Default:
Put simply, don’t bite off more than you can chew when it comes to taking out and repaying business financing. Make sure you understand your business’s financial situation and your ability to make the required payments on time. If the monthly payments seem like a stretch, consider borrowing a smaller amount until your cash flow becomes more predictable.
Once you repay that loan, if you find that your business can afford a larger payment, it might make sense to pursue a bigger business loan. Or, you could pursue another financial product, such as a line of credit, credit card, or cash advance. Again, this will all depend on your business’s finances at the time, in addition to what you’d like to use the funding for.
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.
Editor’s Note: This post was updated for accuracy and comprehensiveness in March 2021.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.