Update May 5, 2021: The general fund for PPP loans ran out of money on Tuesday, May 4, 2021, according to the U.S. Small Business Administration. Pending applications will still be processed, as will new applications from Community Financial Institutions, which service underserved communities. New PPP loan applications from other lenders will not be processed. The PPP loan program officially expires on May 31, 2021, but lenders have until June 30 to process outstanding PPP applications. For the latest information, read our PPP page.
You took out a Small Business Administration loan to grow your business and had every intention of repaying it. But you’ve experienced some hardships and sales are weak. You can’t make payments and are now facing an SBA loan default, which would likely spell doom for your business.
This situation isn’t uncommon: 1 out of 6 SBA 7(a) loans issued from 2006 through 2015 weren't paid back, with the average failing loan taking close to five years to reach the default status, according to a NerdWallet study.
For small-business owners who face default on an SBA loan, here’s what to expect — and some possible resolutions.
When is your SBA loan in trouble?
The SBA isn’t a lender; it guarantees up to 85% of the loan amount to lenders who make SBA loans. The lender who originated your loan is where you'll go when dealing with an SBA loan default.
Lenders typically begin efforts to alert borrowers that they are late on the loan after a 10-day grace period, and they can charge a late fee, says Charles Green, managing director of the Small Business Finance Institute, which trains and coaches commercial lenders.
However, each lender has different policies and procedures for what they do when a borrower stops paying a loan, says Evan Singer, CEO of SmartBiz, an SBA loan provider.
Most banks have departments that try to figure out a new repayment plan with the business owner. This could include a loan restructuring or interest-only payments for a certain period of time, Singer says. Under such a plan, the loan wouldn't be in default.
Borrowers should also note that they could be in technical default on the loan even if they are current on payments. While uncommon, this can happen if a business owner violates the terms agreed to on the loan, like failing to provide tax returns for every year of the loan, taking on additional debt or not getting the lender’s approval when bringing in new shareholders, Green says.
How the lender may try to collect
When a government small-business loan goes into default, the lender will try to collect the full amount from the borrower, calling in the SBA's guarantee only if its efforts to collect fail.
The lender has the right to seize the assets the borrower used as collateral to back the loan. This can include business bank accounts, inventory, equipment or real estate.
“Banks are going to follow their normal policies and procedures to ensure that the collateral can repay the loan,” Singer says.
Borrowers owning 20% or more of the business and individuals that hold key management positions are also required to sign a personal guarantee to obtain SBA loans. A personal guarantee is a written promise that says you agree to pay back the loan personally if your business cannot.
This means if the collateral the business owned doesn't satisfy the loan amount outstanding, the lender has the right to try to collect on personal guarantees made by the owners of the business.
“They can send demand letters to the guarantors, which seeks payment for the shortfall, and they could file a lawsuit in state court,” Green says.
With a personal guarantee, lenders can look to liquidate the borrower’s personal assets, such as real estate and bank accounts, but the laws vary by state, Singer says.
If you default and the lender takes a loss on the loan, it submits the loss to the SBA to honor its guarantee. The SBA guarantees up to 85% on loans of $150,000 and less, and up to 75% on loans over $150,000.
If this comes to pass and the federal government takes a loss on the loan, it can take additional means to get the loss repaid, which could include garnishing wages or freezing bank accounts of the borrower, Singer says.
What to do if you're struggling
The best thing you can do is stay in communication with your lender and let them know that you're making efforts to repay the loan.
If you’re struggling to make payments or suspect you will default, call the lender before they call you. Try to set up a plan to figure out how you can repay the loan without going into default, Singer says.
“It’s never a good idea to default on any loan, but especially one that’s guaranteed by the federal government,” Singer says.
Efforts to repay the loan may include generating more sales, liquidating property or equipment, or even closing or selling the business to make good on the loan, Green says.
“Some people get very emotionally involved in it, and they’ll just ride that ship over the waterfall because they can’t let go,” Green says. “Having a realistic approach to managing the situation is imperative for better outcomes for everybody.”
If you’re going to default on a loan or wish to reach a settlement with the SBA, you may be able to settle for less than the full amount you owe through an offer in compromise. If you go this route, consider hiring an attorney who specializes in business-debt settlement.