Here’s what to do when you’re about to default on a business loan.

Almost defaulting on your business loan is an incredibly difficult experience to go through. You’re not sure what your options are or what next steps you can take. Additionally, really understanding terms like “default” and “delinquency” and what they mean for your business can help inform the next decisions you make.

In this comprehensive guide, we delve deep into what it means to default on a business loan, the distinction between default and delinquency, and the potential consequences of each. We’ll also explore proactive measures you can take before and after a default, and how certain business loans might impact your personal credit.

What happens if you default on a business loan?

Defaulting on a business loan occurs when you fail to meet the stipulated repayment terms set by your lender. This can involve missing scheduled payments, not paying the full amount due, or breaching other conditions specified in your loan agreement. These occurrences are collectively known as events of default.

When your loan enters a state of delinquency, the lender may impose penalties or increased interest rates. Additionally, your lender can report the default to credit bureaus, which can have a negative impact on your credit score and you’ll likely be unable to get another business loan ever again.

What happens if your business defaults on a loan?

• Unsecured loan: Unsecured loans are not backed by collateral. Instead, they are based on the borrower’s creditworthiness.When your business defaults on an unsecured loan, your lender doesn’t have specific assets to seize immediately. However, your lender can take legal action.If you’ve provided a personal guarantee on your business loan and you default, the stakes are high. Not only are your personal assets at risk, but your credit rating can also take a significant hit. Lenders often require this guarantee upfront for unsecured loans, so it’s crucial to understand the gravity of this commitment.

• Secured loan: If you have a secured loan, that means your loan is backed by collateral, which can be assets like machinery or inventory. If your business defaults on this kind of loan, your lender has the right to seize and liquidate the collateral to recover the outstanding amount.

What if I had an SBA loan?

If you default on a Small Business Administration (SBA) loan, you’re still responsible for addressing the lender’s loss. SBA loans often require collateral, so if you default, this collateral can be liquidated.

Remember, the SBA itself is not your lender—the Administration only guarantees up to 85% of the loan for lenders.

If your lender calls on the SBA to guarantee the loan, you’re likely looking at having your wages garnished by the SBA or having your bank account frozen.

What’s the difference between default and delinquency?

Business loan default and delinquency are terms used to describe different stages of a borrower’s failure to meet the repayment terms of a loan. While they are sometimes used interchangeably, they have distinct meanings in the lending world.

• Delinquency: Delinquency begins the moment a borrower misses a scheduled loan payment. During the delinquency period, which can vary based on the lender’s terms, you still have the opportunity to make up the missed payment, but often with added late fees.Here’s an example: Let’s say your business loan payment is due on the 5th of each month. You miss making the payment this month, and now it’s the 6th. Depending on your loan terms, you might have a grace period, say until the 10th, to make the payment without being considered delinquent.If you still haven’t paid by then, your loan officially goes into delinquency. This status can negatively impact your credit score and make securing future financing more difficult.
• Default: If the delinquency status of your loan continues, this is where you run the risk of going into default. Default signifies a more serious breach of your loan agreement.Let’s say you secured a business loan to acquire specialized equipment for your restaurant. The loan terms specify that if you default, the lender can seize the equipment. Unfortunately, if you miss multiple payments you’re in default and the lender can exercise their right to take the equipment.

While both terms indicate issues with loan repayment, delinquency is an early-stage warning, whereas default represents a more critical breach of contract.

What you can do before your loan goes into default

Before your business loan reaches the default stage, you have a number of options to better manage your debt situation.

Before you’ve defaulted on your loan, it’s essential to take immediate and proactive measures to mitigate the consequences and work towards a resolution.

1. Check your business finances: Keeping tabs on your financial health is crucial to avoid defaulting on your business funding. Start by examining your cash flow statements to gauge if you have enough funds for upcoming remittances. If your cash flow is solid, you’re good to go—keep making those payments as planned.
2. Communicate with your lender: Your first step should always be to contact your lender. Open and honest communication can lead to potential solutions such as renegotiating the terms of the loan or setting up a new payment plan.
3. Take a look at alternative lenders: Start looking at alternative lenders with more flexible financing options—you might be surprised at your options.
4. Rebuild credit: After addressing the immediate concerns, focus on rebuilding the business’s creditworthiness through timely payments on other debts, maintaining low credit balances, and regularly monitoring credit reports.

While being on the edge of defaulting is challenging, with the right approach and resources, business owners can navigate the situation and work towards financial stability.

Does defaulting on a business loan affect my personal credit?

Unfortunately, in certain circumstances, defaulting on your business loan can impact your personal credit. Here are a few of the factors that you should be aware of:

• Business structure: Sole proprietorship? Your personal credit is going to be affected if you default on your business loan.
• Loan structure: When you get a business loan,your personal assets are often used as collateral to secure the loan. What does this mean for you? If you default on the loan, not only are your assets at risk, but your personal credit score can also take a hit. Understanding the loan structure and its impact on your personal finances is crucial before entering into any loan agreement.
• Resolution of default: If your default leads to business bankruptcy, you might be looking at filing for personal bankruptcy. Doing this has an enormous impact on your credit score.