What Happens if You Default on a Business Loan?
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Taking on debt is a common way to finance a business, but it can be risky. If you can’t repay your small-business loan, it may fall into default. A business loan default can have a range of negative consequences, from losing your personal assets to bankruptcy.
Here, we’ll review what happens when you default on a business loan and offer tips on how to avoid the situation altogether.
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What is a business loan default?
A business loan goes into default when you repeatedly violate the legal terms of your loan agreement. When you default on your loan, you’ve continuously missed and failed to make payments — and have not reached a resolution with your lender. At this point, your lender has determined that you will not repay your debt.
Business loan default vs. delinquency
Before your business loan falls into default, it will be considered delinquent. Generally, your loan will be considered delinquent after you miss a payment — although this can vary based on your lender and specific business loan agreement.
Your lender may charge you a late fee once you’ve missed a payment, or it may offer a grace period — which could be a few days or a few weeks — and you can avoid the late fee if you make a payment during this time.
If you’re able to make a payment, this will bring your loan out of delinquency. If you continue to miss payments, on the other hand, your loan will likely fall into default.
What happens when you default on a small-business loan?
Once you start to miss your business loan payments, the lender will likely contact you to inform you of the delinquency and try to reach a resolution.
If you fail to respond and your loan falls into default, the lender will make every attempt to collect on the debt. This process may include consequences such as:
You lose your collateral
If you default on a secured business loan, your lender can reclaim your collateral to recoup its losses. For example, if you took out an equipment loan to buy a new tractor and the tractor served as collateral on the loan, your lender could seize this equipment to recover its money in the case of default.
Although unsecured business loans don’t require you to provide specific collateral, many lenders take out a Uniform Commercial Code lien on your business assets. In this case, the lender can still use your business assets to recover their losses if you default on the loan.
>> MORE: What is a high-risk business loan?
You lose your personal assets
Most lenders require you to sign a personal guarantee when taking out a business loan. A personal guarantee gives the lender the right to seize your personal assets to repay debt in the case of default.
When you default on an unsecured business loan, your lender will likely use this method to recover its losses (or a lien, if one is in place). With a secured loan, on the other hand, lenders will start with your pledged collateral and only turn to additional methods if your debt isn’t completely repaid.
Your lender sues you
If you can’t or refuse to use your business/personal assets to repay your debts, your lender can take legal action against you. When your lender sues you, you’ll be responsible for paying your outstanding loan balance as well as interest, fees and additional penalties. You may also have to pay court costs and attorney fees.
Through this legal process, the court will determine the appropriate course of repayment, which may include allowing the lender to garnish your wages, tax refunds or personal bank account to cover what you owe.
You damage your credit
Defaulting on a business loan can have a significant impact on your business (and sometimes personal) credit scores.
Your lender may report late payments, collections and judgments (the result of a lawsuit in which your lender had to sue you to recover debt) to the commercial credit bureaus — all of which can damage your business credit score.
Collections and judgments remain on your report for just under seven years, and while most personal accounts don’t report late payments until 30 days past due, business accounts are reported when payment is just one day late.
It’s important to note that even if your lender typically only reports to the commercial credit bureaus, it may report a default to the consumer credit bureaus as well. This type of damage to your business and/or personal credit can make it harder to qualify for financing.
How to avoid business loan default
It can be difficult to financially recover from a business loan default. If you’re falling behind on payments or anticipate that you won’t be able to repay your loan, here are some strategies you might consider:
Review your business finances
By reviewing your finances, you may be able to identify solutions that will allow you to continue making payments on your loan. For example, you might look through your cash flow statements to see whether you have enough funds at any given time to make your loan payments.
If your cash flow isn’t sufficient, you may reevaluate your expenses to determine whether there are areas where you can cut costs.
On the other hand, if multiple loans with high interest rates are negatively affecting your cash flow, you might consider business debt consolidation to combine these loans into one new loan — ideally, with a lower interest rate and better terms.
Talk to your lender
At the end of the day, the lender wants you to repay your debt. So, if you’re having trouble making payments, talk to your small-business lender before you reach the point of default.
If you contact your lender and you’re upfront and honest about your difficulties, they’ll likely be more willing to work out a resolution, such as:
Deferring your payments for a period of time.
Adjusting your loan terms to make payments more manageable.
Lowering your interest rate.
Allowing you to just pay interest on the loan for a period of time.
Work with a professional
If you’re struggling with your finances, it might be useful to work with a business professional, like a certified public accountant or an attorney. These experts can review your situation and offer personalized recommendations on how to manage your payments and avoid default.
A business attorney can also help you negotiate a resolution with your lender or a debt collection agency as well as assist you through legal proceedings (if necessary).
To find access to low- or no-cost financial and legal advice, you can reach out to your local Small Business Development Center or similar business service organizations, like SCORE.
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