Worried about not paying back a business loan? This is what to do if you're facing a business loan default.
Almost all business loans will require that you pay them back in monthly installments, with interest. A default is what occurs when you fail to make these repayments. All your defaults are listed in your business credit report, meaning they will have long-term negative effects.
What happens when you default on a business loan?
When a loan goes into default, the lender may be allowed to reclaim their money in other ways. Their options depend on what kind of loan you took out.
- Secured loans and equipment loans. This is when you borrow against an asset such as your house or car, or a business asset, such as the equipment you're buying with the loan. In most cases your lender will take possession of these assets and then sell them off to recover its money. This is known as foreclosure.
- Unsecured loans. These are loans taken out without collateral. When you fall behind on paying these back, your lender will generally impose additional fees and raise your interest rates. When you enter default your lender might turn the matter over to a third-party debt collection agency that will try to collect the money on the lender's behalf. If this doesn't work then they might take you to court. The courts have the power to order measures so that the lender can reclaim its debt, which may include garnishing your wages or even the seizing and selling off of your personal property to recover costs.
Have you defaulted?
Some lenders will only record a default after months of missed repayments and several warnings, while others will quickly do it following any missed repayment. Familiarise yourself with the default terms and conditions when taking out a loan. If your loan has gone into default your lender will contact you.
Can the lender come after me, or just my business?
This depends on the type of loan you took out. Usually, the lender can only pursue your business assets and not your personal ones. For example, if your business goes bankrupt with outstanding debt, the lender might be able to claim and sell off your office space and office furniture, but not your own house and furniture. However, there are exceptions to this:
- If you secured the loan with personal property. The lender can claim this property whether it's a business asset or your own.
- If you signed a personal guarantee. Some business loans require you to personally guarantee them, making you personally liable for unpaid debts. This can get you better rates, but also makes it riskier. If you have personally guaranteed a loan then a debtor is able to pursue you directly and claim your personal assets.
What do you do if you're having trouble repaying a loan?
There are two things you should know before a default occurs, and ideally before even taking out a loan:
- What are the lender's procedures for late repayments? How does the lender differentiate between late payments and defaults? What are their fees and penalties, and how do they define a default? For example, some lenders will call a default if you're a month behind on payments, while others will only do it after three months.
- What is the lender allowed to do to recover their money? This depends on whether you have a secured or unsecured loan, and whether you personally guaranteed it.
Knowing these allows you to determine how serious your financial situation is and how lenient the lender is likely to be. If you have an unsecured loan without a personal guarantee, and negligible business assets, your lender stands to lose money if your business fails, giving them more incentive to go easy on fees and be more lenient with repayments.
Lenders and business loan defaults
Your lender really doesn't want to see you default any more than you do, no matter what kind of loan you have. Initiating legal proceedings, hiring a third-party debt collector and seizing assets is neither cheap nor easy, so it's usually only done as a last resort. The lender knows that even bumping up your fees or interest rates can make it harder for you to repay the loan. Almost all lenders would prefer to offer you an extension or adjust your repayment schedule than initiate default proceedings.
Other than tightening your belt and cutting costs, there are really only two options for you if you think you are going to default. The first and best is to contact your lender.
Call your bank or lender, or go see them in person
They may have already been in touch with you, informing you that you are in default or behind on repayments. This is the time to get in touch, not to avoid them.
You should ideally contact them before you officially enter into default so that the lender can adjust your loan for you to more easily make repayments. This way you don't lose the business loan and the bank doesn't have to initiate cumbersome recovery procedures.
When you contact the lender, it will generally do one or more of the following:
- Work with you to adjust your borrowing arrangements and repayment schedule to find a plan that suits your budget
- Discuss your business, ask to speak with your accountant or advisers and help you make plans to improve cash flow or profits
- Recommend a specific financial adviser who can help you, direct you to speak with your own accountant or adviser or put you in touch with an independent third-party that might be able to help
Refinancing your business loan
This is not always the right course of action, but can potentially be an excellent option, particularly if your current loan has unfavourable rates.
Refinancing a business loan involves taking out a new loan with a different provider and then using this new loan to completely pay off and close your old one. Here's what you should consider before you refinance your business loan:
- Calculate exactly how much you will save by refinancing the loan and don't proceed unless you're absolutely certain about it.
- Make sure to factor in the fees that will apply when taking out a new loan and closing your old one when looking at value for money.
- Consider factors such as whether you're refinancing to a secured or unsecured loan and whether you are giving a personal guarantee on the new loan. It can be good to get out from under the risk of these when refinancing, but it also makes getting better rates more difficult.
If you already have a good loan with good terms, then it's possible that you simply won't be able to find a refinancing option that's a good enough step up. Refinancing is not always available, but it's an option that should be investigated before you go into default.
What does a default mean for your credit history?
Your credit history is a file that financial service providers look at when deciding how fiscally stable and secure you are, how risky lending you money is and therefore what kind of interest rates and fees you'll get. Riskier borrowers are more likely to have to pay extra costs or be declined outright.
All loans, loan enquiries, credit card debts and other outstanding expenses are included in your credit history. The more of these there are, the riskier you are seen to be. Defaults are also specially listed and will count against you in a major way, marking you as much riskier than someone without any defaults.
Defaulting on a loan, therefore, has significant long-term financial impacts, and can make loans and other financial services more difficult and expensive to get. Your lender has to mark in an official default before this happens, which is why it's so important to get in touch with them before defaulting on a loan.
Your business is its own distinct legal entity, and therefore has its own credit history, separate to your personal one. When you default on a business loan, it will generally not appear on your personal credit history unless the loan was personally guaranteed or your personal finances were otherwise closely involved.