Once a small business loan goes into default, the situation is likely to get much worse than it already is. Defaults can cascade. The company’s lender may “accelerate” the loan, which means it calls the balance due immediately, and the company owes all of it rather than only the missed installments. The lender may take the company to court to collect the funds, eventually seizing business or personal property. It may also report negative information to the credit bureaus, damaging the company’s credit — and perhaps the owner’s personal credit, too. By the end of this post, you’ll understand what you can expect should you default on your loan.
Acceleration catches many owners off guard. Now, the entire amount of the loan is due all at once, and the owner usually doesn’t have that kind of money lying around.
Borrowers default when they slip three to six months behind, though some lenders and some contracts let it happen even sooner. So you should check your loan agreement to see what happens when you fall behind. If you’re at risk of falling behind, assess your business’s finances and contact the lender immediately. The sooner you do that, the more likely you’ll find a solution that works for both sides of the table, and the less your credit and your business will be harmed in the process. Calling first is the smart move, even though that’s the opposite of how most people behave. Especially if they can’t afford the loan payment — why would they want to call their lender and reveal to the lender the fact that they are in trouble? It’s understandable, but just doesn’t make good business sense.
Business Credit Scores
Business loans show up on your company’s own credit report. The three main business credit reporting agencies, Dun & Bradstreet, Experian and Equifax, collect information from lenders and credit card issuers, court records, state agency filings, debt collectors and more. Credit scoring services use the data to produce a credit score that lenders and vendors may reference in order to assess your business’s creditworthiness. Your business’s credit report and score are separate from the personal credit report and score of the owner or managing member, and the information exists in separate databases. But they share some key characteristics. Payment history has an outsized effect on business credit scores (just as it does on personal scores). Late payments on a business loan will drag down the company’s score. A defaulted loan or one that goes to collection, or a bankruptcy filing, will also appear on the business credit report and lower the score.
How can a business loan hurt your personal credit score? The big part of this depends on what kind of legal structure your business has. If you are a sole proprietor, your personal credit will almost certainly take a hit in the event you cannot repay a business loan. The way the loan was set up matters too. You might still face personal liability even if you’re not a sole proprietor, if your personal credit was used to get the loan. It’s very common for lenders to ask for a personal guarantee on startup loans to small companies with a limited credit history, as well as on SBA loans. With a guarantee, you can be on the hook if your business fails. If your business defaults on its payments, the lender may pursue you personally to recover the money they are owed, and it may report negative information to your personal credit history. Check your loan paperwork if you’re not sure whether you signed one.
Then there is how the default ends. If the default results in a business bankruptcy that could put the owner’s personal assets at risk, he or she may wish to consider filing for personal bankruptcy. (Of course, a personal bankruptcy filing will seriously impact personal credit.) The owner may also benefit from consulting with a bankruptcy attorney.
The damage also follows you forward. Once it becomes tainted, a battered business credit rating can affect a company’s ability to obtain loans or credit in the future—including credit lines from suppliers— which can hinder a business’s efforts to keep operating or rebound. And a seriously damaged credit rating will make it harder to re-borrow as circumstances change and improve.
Collateral on a Loan
If you put up business or personal property as collateral on a loan, you can lose it if you default. For a business, losing key assets such as buildings and equipment can mean going out of business. Personal assets, such as a home or personal bank accounts, can be at risk as well, depending on how you structure your loan. For a lot of owners, this is the part that keeps them up at night. They don’t want to lose their homes and everything they’ve built.
The SBA guaranties up to 85% of an SBA loan, so the lender may be able to recoup some of its loss if you default. But it won’t spare you collection activity or a mark on your personal and/or business credit. If the SBA gets involved, the borrower still owes the debt, and the SBA may collect by putting a tax lien on the borrower’s assets or garnishing the borrower’s wages.
Solutions Do Exist
Though the potential consequences of loan default can be severe, solutions do exist to get you out of trouble. Figuring out your options if you can’t repay a business loan is tough. If you can, reach out to your lender before the loan goes into default. The sooner you talk to them, the sooner you can discuss your options. Because lawsuits are expensive for lenders too, many will try to negotiate with struggling borrowers to avoid default. For example, they may let you restructure the loan or delay regular payments in exchange for interest-only payments for a while. A borrower may want to also contact a nonprofit credit counseling agency, a debt settlement attorney or a bankruptcy attorney. Stay in touch with your lender early and often and become an expert on the details of your contract. Early advice can minimize any damage to business and personal credit and help you plan the right path forward.
