Yes. In fact, the weeks before a default are usually the best time to bargain a settlement with your lender. If you are having trouble paying back your business loan, it is in your best interest to contact your lender and negotiate. The sooner you call the lender, the better off you are.
Delinquency and Default
To see why timing matters so much, it helps to understand the difference between delinquency and default. A business loan is delinquent the day after it’s due, or a few days later if there is a grace period. The amount of time before a business loan is delinquent depends on the lender. During that stretch you can still make up the missed payment, usually with late fees added. It is worth remembering that being in a delinquent position is not necessarily a death sentence. Often, you can work it out with the lender and save a default.
Defaults typically happen over a period of time. A default is not something that occurs overnight. If the delinquency drags on, you risk default. Defaulting on a business loan is a serious breach of contract with your lender, and you are likely to have consequences. Imagine you borrowed to buy specialized equipment for your restaurant, and the agreement says the lender can take it if you default. Miss multiple payments and you are in default, and the lender has the right to repossess the equipment. That’s why it’s important to try to negotiate with your lender as soon as you know you won’t be able to make a payment. If you haven’t defaulted, you have more options.
Once a Loan Is in Default
It helps to know exactly what you are trying to avoid. Once a loan is in default, the lender may increase your interest rate and/or add additional charges. It can also report a default to the credit bureaus, which will hurt your credit. What it does next depends on the type of loan you have. A secured loan is backed by collateral. It could be equipment or inventory. A default under that loan gives the lender the right to take possession of and sell that collateral. An unsecured business loan is not backed by collateral. The lender has no specific assets to seize right away, but it can still take legal action, and when you sign a personal guaranty, you are creating personal liability. The lender can now collect against your personal assets. Lenders often ask for that guaranty up front on unsecured loans.
SBA loans add a wrinkle. The SBA guarantees up to 85% of the loan for the lender. But the Small Business Administration did not actually provide the loan. The bank did. If you default, you are still responsible for the lender’s loss, and since SBA loans often require collateral, that collateral can be liquidated. If the lender calls on the SBA guarantee, you will likely face wage garnishment or even have your bank account frozen by the SBA. In all cases, whether you have a secured loan, an unsecured business loan, or an SBA loan, it is often in your best interest to call the lender and negotiate as soon as possible.
Review Your Cash Flow Statements
So what should you do while you still have time? Review your cash flow statements. Look at how your business is doing. Look for trends. Are profits increasing, decreasing, or staying flat? Is the balance of cash coming in and going out reasonable? That means finding out where your money is going and tracking it. Only if you know how much you can actually spend do you know if your payments are even feasible. If the cash is there to cover your upcoming payments, keep making them as planned.
If you can’t make a payment, you need to talk to your lender. And to make that conversation productive, you need to come to the table ready. Sit down and prepare. Know what you want to say and what the bank is likely to say in return. Remember, you can always renegotiate the payment terms if your lender agrees to it. If they won’t, keep looking for another lender. Alternative lenders often have more flexible financing options than you might expect. And once the immediate crisis is behind you, rebuild your business’s creditworthiness: pay other debts on time, keep credit balances low and check your credit reports regularly.
As business owners, it’s natural to worry about the effects of a default on a business loan on your personal credit. Those effects are real in certain circumstances, and a lot depends on how the business is set up. If it’s a sole proprietorship, your personal credit will be affected. That’s because the liability runs all the way down to you. Loan structure matters too. Your personal credit can suffer if the business defaults and you provided personal assets as collateral to secure the business loan. Those assets are on the line as well. Know exactly what you are committing yourself to before signing an agreement. And if a default leads to business bankruptcy, you may end up filing for personal bankruptcy as well, which has an enormous effect on your credit.
A default doesn’t necessarily mean failure, or that you can’t get financing ever again. It means being smart about the next steps and finding a company that can see past the credit history. That said, it is always better to act before it gets that far. Don’t wait until you are actually in default to take action. If you find yourself unable to pay your business loan, contacting the lender early is your best move. Speak with your lender to discuss how to alter the loan or to create a new payment plan. Knowing the importance of timing can help you avoid the worst consequences. Being proactive and prepared will serve you well.
