Small Business Loans Tips
What happens if I do not Repay a Business Loan?
Despite their best intentions, small business owners may find themselves facing the possibility of defaulting on a small business loan. Unexpected catastrophes such as a flooded kitchen, or delayed inventory shipments, could impact your business negatively and leave you unable to make payments. A dissatisfied customer could file a lawsuit and bury you under legal fees.
Business owners who had every intention of repaying a small business loan can easily fall behind on payments and eventually default. If you’re considering default, you’re probably wondering what happens if you don’t repay a business loan.
The Lender Will Try to Collect
Expect your phone to start ringing within one or two missed payments. Lenders vary in how quickly they will begin following up on missed payments, but they will contact you. Letters, emails and phone calls, a lender will utilize any and every contact method to try to collect on the loan.
Many lenders have in-house collections departments where they will send the loans. Other lenders sell the debt to a third-party collection agency. It is in your best interest to deal with a lender who has an existing relationship and other accounts with you. They will be more motivated to salvage the relationship.
Lacking this motivation, a third-party collection agency will be more aggressive in pursuing collection and far less willing to negotiate. Do not make the mistake of thinking that, if your debt is charged off and sent to a collection agency, it will not impact your credit. Collections activity does appear on your credit report.
Default will be Reported to Credit Bureaus
Your personal and business credit scores will both be impacted by default. Lenders don’t typically report an odd, one-off late payment as the paperwork involved is not worth their time. But once you go several months past due they will report it to the credit bureaus.
While lenders used to report late payments for just one month, it takes time and resources to provide that information to the credit bureaus. Now they typically wait until you’ve had more than one or two late payments, particularly if they’ve occurred in a row. However, no lender is willing to go on record that this is their policy and it’s not recommended that you count on it.
If you normally make regular, on-time payments and just forget one month, always pick up the phone and call. Request that the late fee be waived, if possible, and that it not be reported if they were going to send it in. Lenders are often willing to be flexible with good customers as qualified lenders like Shield Funding adhere to borrower’s rights policy.
Payment history makes up 35 percent of your credit score. Once those late payments hit your credit report, your score will dip lower. A lower score makes it harder to obtain additional funding or refinance existing debt.
Loan defaults and late payments stay on your credit report for seven years. If an account remains open, the late payment will fall off at year seven while the account stays on your report. Even if you get your business back on track that default could have long-term consequences for your business’ ability to obtain capital and you may have to resort to business loans with bad credit which will come with higher rates.
Personal Guarantees and Collateral
If you took out a secured business loan, your lender will have the right to seize the collateral that you pledged. In some cases, a loan is taken out to purchase the equipment that serves as collateral. For example, a bakery obtains a loan to purchase commercial mixers, and when they default the lender seizes the mixers.
In the case of a small business loan for which you gave a personal guarantee, the lender has the right to pursue seizing your personal assets. Personal bank accounts, your house, or your car, could all be fair game. Even if you didn’t provide a personal guarantee if your business is structured as a sole proprietorship the lender can go after personal assets.
Your Lender Could Take You to Court
Signing a loan creates a legal obligation for repayment. Therefore, a lender can enforce this legal obligation through the courts. Given the expense of legal processes, lenders typically only go this route if you have been ignoring all attempts to contact you.
Legal processes include;
- Liens on Personal Assets
All legal actions become a matter of public record. Unlike actions which will eventually roll off your credit report, they will always be searchable in online records.
You Might be Asked to Sign a Confession of Judgment
A confession of judgment (“COJ”) is a legal document in which you forfeit the right to defend yourself in court. Once notarized, the lender may have the right to freeze your account and other assets. More and more, lenders are asking borrowers to sign these letters in advance.
There is risk involved in lending to a small business, particularly if it is an unsecured loan. Confessions of judgment offer protections to the lender. In this letter, both parties agree preemptively what will happen if the borrower defaults.
You have pre-negotiated a settlement in case of default. This could include garnishment of your wages or future profits, but in return, you waive your right to a trial. Before signing a COJ make sure that you thoroughly understand each clause and its impact on your financial future.
A Co-Signer Will be Impacted
When your parent, business partner, or loved one co-signed on your loan they agreed to share legal responsibility. Therefore, if you default they will be impacted.
A lender could pursue repayment from a co-signer. They could also try to seize a co-signer’s assets or freeze their accounts. If you are at risk of default, talk to your co-signer and inform them of the situation. See if they would be willing to lend you the money to get current, or help in the meantime, as it will also affect their credit report.
Try this before you default…
Defaulting on a small business loan has serious repercussions. It will appear on your credit report for years after the default, impairing your ability to obtain funding even after your business has recovered. It could impact your personal life, too, if you pledged any of your personal assets such as a house.
While you may think that default is inevitable, that is not always the case. Before you go into default on your business funding, try these tactics.
Talk to Your Lender
It may be tempting to bury your head in the sand and toss the collection letters in the trash, but that is not a good idea. It costs a lender time and money to pursue collections or legal proceedings if you default. Often, it benefits both of you to work out a repayment plan.
Pick up the phone or go into the branch and talk to the lender. Explain the circumstances that have led to you falling behind on payments. Then ask what they can do.
Ask if your lender can temporarily reduce your interest rate or payment amount. Sometimes you can arrange for interest-only payments for a short period. Inquire about re-financing the loan or consolidating loans, or for late fee forgiveness. If you can present a plan to catch-up, that is even better.
Lenders want to get paid and are often willing to make concessions and work with a client who has demonstrated that they are making every effort to solve the problem.
Ask if You Can Settle the Loan
When a lender has to pursue repayment, they incur additional costs which eat into their profits. Legal fees and collection agency fees are two of the biggest. Even if they can seize collateral, they are not typically in the business of reselling mixers.
For this reason, a lender might be willing to settle the unsecured business loan for less than its face amount. If the total outstanding is ten thousand dollars, for example, they might be willing to accept payment in full for ten to twenty percent less. If you can come up with the money to settle it will still appear on your credit report, but not as a full default.
Ask for Deferment or Forbearance
What if you absolutely cannot make any payments for the next few months? A major health issue has landed you in the hospital, and your business will not bring in any revenue until you are released.
A deferment reduces or postpones repayment. Deferment does not hit your credit score, but it will cost you. Interest can continue to accrue. Forbearance is similar. If approved, you can temporarily stop paying on your loan or make payments at a lower rate.
Even if unsuccessful in arranging for full deferment or forbearance, you might be able to stop late fees and interest charges from accruing while you catch up on your payments,
Defaulting on a small business loan should not be taken lightly. If you think you might be in danger of defaulting on a small business loan, it is in your best interest to talk to your lender immediately. Lenders dislike surprises, and a demonstrated willingness to keep them informed and work to repay your debt will go a long way to mitigate the situation