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When you take out a small-business loan, you intend to pay it back. But small businesses are risky, and missed loan payments happen. Here’s what you need to know about loan delinquency: why it happens, how to avoid it and what to expect if you can’t repay.
Why small-business loan delinquency happens
Delinquency is when a borrower misses a loan payment or pays late. It can happen when businesses don’t get paid on time by customers, lose large contracting jobs or experience theft or fraud, says Sid Jajodia, LendingClub’s vice president of small business. Additionally, some businesses become delinquent during a dip in an industry or economic cycle; many construction companies were delinquent in 2009, he says.
“It’s never any one reason — businesses are complicated,” Jajodia says.
What it means to default
Lenders consider loans “in default” after the loan is delinquent for a certain amount of time; the time period depends on the lender. On the whole, business borrowers tend to repay their loans, but online small-business borrowers fail to pay more often than other business borrowers. The rate of charge-offs (defaulted loans that lenders don’t expect to be repaid) for business loans from all commercial banks peaked at 2.6% at the end of 2009 and is now less than 1%, according to data from the Federal Reserve Bank of St. Louis.
Lenders consider loans ‘in default’ after the loan is delinquent for a certain amount of time; the time period depends on the lender.
Online small-business lenders have slightly higher charge-off rates. We looked at charge-off rates for OnDeck and Lending Club because, as they are the only two publicly traded online small-business lending companies, we had access to the data.
OnDeck charges off a loan if the borrower hasn’t paid after 90 days, according to the company’s initial public offering filing with the U.S. Securities and Exchange Commission in 2014. OnDeck’s net charge-off ratio hit a high of 9% for loans originated in 2008 and then leveled out to roughly 6% in subsequent years, according to the SEC filing.
Lending Club charges off a loan if the borrower hasn’t paid after 150 days, according to the company’s website. However, Lending Club’s charge-off rates for business loans aren’t yet reflected in its data because the company, which began as a consumer lender, expanded to business lending in March 2014.
What to do if you’re at risk for missing loan payments
Approach your lender, says Gregg Landers, managing director at financial services firm CBIZ. Lenders “typically don’t like surprises,” he says. Some lenders are willing to work with at-risk borrowers to help them catch up on missed payments and get back on track.
Some lenders are willing to work with at-risk borrowers to help them catch up on missed payments and get back on track.
If your lender is willing to work with you, there are tools they can use to help you avoid default, says Larry Chiavaro, executive vice president of First Associates, a loan servicing company. First Associates is the primary loan servicer for 15 online small-business lenders, Chiavaro says. Lenders may agree to accept partial loan payments for a few months until you can catch up, postpone your loan repayments until your business is cash positive, or extend your loan term to lower your monthly payments, Chiavaro says.
What to expect when you miss payments
Different lenders have different ways of servicing delinquent loans. For example, LendingClub gives borrowers a 15-day grace period to make up the missed payment with no penalties, according to the company’s website. If the borrower hasn’t made the payment after 15 days, LendingClub charges a late fee of 5% of the missed payment amount or $15, whichever is larger. Beyond that, LendingClub may call a collections company to try to recoup the missed payments.
For OnDeck loans, repayments are automatically deducted from a borrower’s bank account on a daily or weekly basis. A payment is considered delinquent when the borrower’s account has insufficient funds when the company tries to deduct the payment. If possible, OnDeck works with borrowers to create an alternative payment plan with smaller payments and a longer term, according to a 2014 report by credit ratings agency DBRS.
“Our goal is really to work with our customers to help them through it,” says OnDeck chief marketing officer Andrea Gellert.
However, if OnDeck attempts to withdraw three consecutive payments with insufficient funds, the company stops the automatic deductions and considers the loan in default, according to the DBRS report. The company will continue collections efforts and pursue litigation if necessary to recoup the missed payments.
The consequences of a defaulted loan
Lenders will gradually become more aggressive with their collections strategy as loans become more delinquent. They report delinquent loans to personal and business credit bureaus, so your personal and business credit scores will take a hit, Chiavaro says. Dings to your credit score will make it harder to get a small-business loan in the future.
If you agreed to a personal guarantee in the loan agreement, or the lender has a lien on your business’ assets, the lender can seize your personal or business assets to recoup losses.
The bottom line
If you miss a payment on your small-business loan, lenders will generally be willing to work with you to rectify the situation, as long as you’re communicative and forthcoming about the challenges you’re facing. If you ignore collections calls, however, and don’t make up your missed payments, the consequences for missing payments can become serious fast.