You’ve opened your first small business, and at first, you were succeeding and growing, but over time, sales have slowed. Suddenly, paying your bills and small business loans is getting harder. Unfortunately, for many small businesses, this is not an uncommon situation – around 20% of businesses started in 2016 failed by 2021.
Being unsuccessful in starting your business is a scary prospect. After all, what will happen to your business, and what happens to your small business loan if the business fails? Depending on the loan and the lender, there are a few different scenarios that might occur.
What Happens When You Miss Payments on a Loan
When you are struggling to pay your personal bills, you also do not have the cash flow to pay on your small business loans. Not paying on your loans can greatly impact your finances and business. If possible, it’s best to try and prioritize paying your small business loans or if you foresee any trouble paying them, speak with your lender to work on a solution.
Missing one payment
Luckily, missing one payment on your small business loans won’t do too much damage as long as you are able to make future payments consistently. Your lender will more than likely charge a late fee and may call to see why you missed the payment or why it’s late. Be sure to answer them and explain the situation. Often lenders can help you move your payment date or work with you to pause payments until you are able to pay again.
Be sure to pay as soon as possible to avoid doing damage to both your business and personal credit. Federal law prohibits lenders from reporting a late payment to the credit bureaus until it’s at least 30-days past due. Once the payment reaches that mark, lenders are likely to report the missed payment, dropping your credit score and being on your credit report for up to seven years.
Keep in mind that partially paying on a missed payment will not prevent your account from being reported late or sent to collections. Only if you pay in full will your loan be safe. If you know that you will be late with a payment or will have trouble paying it, speak to your lender as soon as possible to avoid any issues.
Missing multiple payments
Although missing one payment may not have serious consequences, as long as you pay within 30 days, making multiple payments late or missing several in a row may cause the loan to go into default. Before you go into default, though, you will be considered delinquent.
Being delinquent means your lender might charge late fees on the missed payment or even increase the loan’s interest rate, which could result in higher monthly payments. However, at the stage of delinquency, you still have a chance to speak with your lender and prevent the loan from going into default.
Be aware that each lender is different, and the terms of the loans will vary. Some lenders could consider defaulting on your loan after a few missed payments in a row, while others will look at the whole situation and see if there is a pattern of payments and missed payments.
When you become at risk of default on your small business loan, your lender should reach out to you to figure out why you have missed payments. If they do not, be proactive and face the situation head-on to speak with them and explain why you are missing payments. They may be willing to work with you to avoid failing on the loan and the business.
What Happens to Your Small Business Loans if Your Business Fails?
Your lender may consider your loan at default if one of the following occurs:
- Multiple missed payments
- Insufficient funds in a bank account to collect the payment
- Payment is at least 30 days late
If you are worried about not being able to make payments, talk to your lender, and make sure before signing the small business loan you understand the risks you are taking. Don’t put up any collateral you can’t lose if the business doesn’t work out, and instead, look for other funding options such as angel investors or small business grants.
Many lenders will work with you to prevent the default from occurring, but sometimes it may be unavoidable. Should your loan go into default, you will be at risk for the following:
Damage to your credit score
Late payments and missed payments will be put on your credit report for your business and personal credit. Any defaults or delinquencies will stay on your credit score for up to seven years.
This will make getting a future loan more difficult and take some time to recover. Finding loans will become harder as well because of your lower credit score. Many lenders will see this as a risk and increase interest rates to ensure the loan doesn’t default again.
By not paying your loan, you may be at risk of your account being sent to a collections agency. Suppose you ignore these calls, and your lender calls. In that case, the lender has a right to sue you to collect any debt or even liquidate any collateral you’ve put up against the loan, including the business itself or personal assets. A lender will try to avoid going to court over a loan in default due to the expense of legal fees but will do so if they cannot reach you. Some of the legal processes that may occur may include the following:
- Liens on Personal Assets
Late payments on small business loans often have associated fees, causing even more debt. Defaulting on a loan means you have a lower credit score, which causes higher interest rates later down the road for any other business loans you may try to take out.
Personal guarantees and collateral
Defaulting on a loan means that the lender can seize any personal guarantees or collateral. Many loans, such as commercial real estate loans, will use collateral to back the loan and negate the risk. The lender then has the right to take any equipment, property, or inventory used in the loan as repayment.
In the case of a personal guarantee for a loan, the lender can pursue any personal assets, such as bank accounts, houses, or cars. The same is true if your business is a sole proprietorship; the lender may look into your personal assets to pay back the loan.
What Happens if You Default on an SBA Loan?
Many small businesses rely on SBA loans to fund their ventures. The Small Business Association backs SBA loans, and the process varies slightly from a traditional small business loan when an SBA loan goes into default.
As with a regular small business loan, the lender will try to collect first the failing loan from the borrower. This includes collecting any assets that were used as collateral, including inventory and real estate. Before issuing a loan, the SBA also requires an unlimited personal guarantee if the borrower owns 20% or more of the business. The personal guarantee means that if the business assets do not cover the full amount of the loan payments, the lender may be able to seize personal assets through a lawsuit.
If the lender does not receive the full amount between business and personal assets, they can contact the SBA for repayment as part of their guarantee. However, the SBA only pays up to 85% on loans of $150,000 or less and only 75% on loans over $150,000.
Since the SBA is a government program, it means that if they take a loss on a loan, there is a possibility the borrower will face garnished wages or freezing of their bank accounts.
Preventing Your Loan from Failing
Having a loan default is the last resort; no business or lender wants that to happen after all. Instead, you can take a few preventive measures if you are having trouble paying back your loans and are worried about your business failing.
The first and best solution is to speak to your lender. They will be able to work with you to either pause payments, set new payment dates, or even negotiate the terms of your loan if you are heading into default territory.
Lenders will often be able to help you find a solution, but if they are unable to, you still have other options to consider, such as:
Debt Consolidation – If you have taken out multiple small business loans and are struggling to pay them, debt consolidation may help to ease some of the burdens. Debt consolidation combines two or more small business loans into one larger one. Although the principal payment amount might be the same, you may be able to get a lower interest on the new loan, which can help save you money.
Small Business Grants – Small business grants are good options for certain businesses that can qualify for them, such as non-profits and businesses owned by minorities or women. Grants give you funds that you do not have to pay back. While they must be used for specific purposes, the money you save by using grants can help pay down a small business loan.
Crowdfunding – Today, many projects and businesses are solely created through crowdfunding with extensive campaigns. Although not a traditional option, trying crowdfunding to increase cash flow can help prevent your business from going under.
Consider Settling – Some lenders may be open to settling an unsecured small business loan for less than its face amount. Settling on a loan would mean paying for part of the remaining balance in order to avoid the loan going into default. Depending on the amount owed, settling can be helpful to lenders to avoid additional costs in their profits through legal fees.
Ask for a Deferment – Deferment can be a popular option if you cannot make payments and can work with your lender to agree to it. When you defer your loan, you reduce or stop payments altogether, not impacting your credit score. Interest will continue to accrue on the loan, so be sure you can make payments at a higher rate once the deferment ends.
As a last resort, if you are concerned your business is failing, and you can’t find other funding to pay back your loans, consider looking into bankruptcy. While it’s not the best option and will affect your credit, it may help you from having assets seized if your loan defaults.
Before declaring bankruptcy, speak to a lawyer who specializes in it to understand the effects it will have on you and your business.
How to Recover if Your Business Fails
If you have tried everything to prevent your small business loan from defaulting or going bankrupt, but it still happened, there are still ways to recover.
A failed business loan impacts the borrower’s business and personal credit. Building back credit takes time but is doable. Make all future payments of loans and credit cards on time, and pay in full each month to avoid a rotating balance.
If you are still holding on to the business even after the loan defaults, look for ways to increase cash flow and trim expenses, if possible, to pay the other bills on time. You may even consider selling the business before you miss other bills or loans. It might be hard to give up on a dream, but you may be able to protect your financial future by selling.
Keep Your Business From Failing
Starting a small business can be challenging, and keeping it going can be even more difficult. If you have small business loans but are struggling to pay them, speak to a qualified lender at SouthEast Bank to discuss your options.
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Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.