Thursday, August 11, 2016

What Happens When You Default on a Loan?

You took out a small business loan with the best of intentions…

But things didn’t quite work out the way you’d planned—and now you can’t make your loan payments.

What happens when you default on a loan? While the specifics vary depending on your lender, type of loan, and loan agreement, here are some general guidelines about what to expect.

Defaulting on a Loan

As soon as your loan is considered in default, the lender will contact you. Some lenders count one missed payment as “default,” while others will wait 30 days, until you’ve missed multiple payments, or (if your payments are automatically withdrawn from your bank account) until there are insufficient funds in your account to collect the payment.

As time goes by, your lender will become more aggressive.

Your account might be sent to a collections agency and you might start getting a lot of collection calls. In addition, your lender will report each missed payment to the business credit reporting agencies and/or to personal credit reporting agencies, which can hurt your credit score. The more payments you miss, the more damage will be done to your credit score.

So, let’s learn what happens when you default on…

A Secured Loan?

A secured loan is one in which you put up collateral as security for the loan. If you default on the loan and can’t work out some type of agreement with the lender, the lender will seize the collateral, liquidate it and take the money.

An Unsecured Loan?

Unsecured loans are those that don’t require putting up collateral.

Once you miss a payment, the lender will generally begin charging late fees and might also raise the interest rate on your unsecured loan. If they can’t collect on the loan, they’ll likely file a lawsuit against your business. Depending on the terms of the loan, they might be able to grab some money from your business bank accounts or seize business assets such as vehicles, equipment or real estate your business owns.

A Loan You Personally Guaranteed?

If the lender can’t collect on your loan and you signed a personal guarantee, the lender is now free to file a lawsuit against you.

If they succeed, they’ll be able to seize your personal assets—even if your business is structured as an LLC or corporation to protect those assets. In addition to recovering the amount of the loan, the lender can also recover additional fees and penalties, as well as the cost of the lawsuit they filed. Ouch!

An SBA Loan?

Here’s where things can really get ugly. Banks make SBA loans, but a percentage of the loan amount is guaranteed by the federal government. If the bank can’t collect on the loan, the federal government will step in.

First, the bank will try to collect on the loan under the terms of the SBA loan agreement. This might include seizing business and personal assets that were pledged as collateral or through a personal guarantee. If this still isn’t enough to pay off the loan, the lender will file a claim with the SBA to collect the amount that the SBA guaranteed.

Dealing with the SBA after you’ve defaulted on a loan is kind of like dealing with the IRS when you haven’t paid your taxes:

The SBA will ask you to either pay off the remainder of the loan within 60 days or to make an “Offer in Compromise”—in other words, an offer to pay a percentage of what is owed. The SBA then examines your business finances to see if they’re willing to settle for your Offer in Compromise.

If not, the U.S. Treasury Department takes over. The Treasury can collect the balance owed by garnishing tax refunds, bank accounts, wages and more for as long as it takes.

Avoid Defaulting on a Loan

Defaulting on a business loan hurts your credit score, makes it harder to borrow money in the future, and can even lead to business and personal bankruptcy. Before you ever borrow money, make absolutely sure you have a plan for paying it back.

As soon as you find you’re at risk of missing a payment, contact your lender. Lenders hate surprises, and if you’re open about the situation, many will work with you to help you make up missed payments and get your account back in good standing.

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