If you’re reading this, there’s a good chance you’re struggling to keep up with your SBA loan payments. You might be scared of what comes next. I’ll give you the facts. I won’t sugar-coat it. I also won’t blow things out of proportion. What happens next? It depends on whether you have a direct loan or a loan guarantee. SBA loans are mostly guaranteed loans offered through local lenders, up to a maximum of 85% of the original loan balance. The SBA also lends directly, but only via an EIDL or Physical Disaster Loan, and only after it has determined the business cannot receive credit elsewhere. Note that the COVID-19 EIDL program stopped accepting new applications in January 2022. Why does this matter? Because the consequences of a loan default are different for a direct loan versus a guaranteed loan.
Payments Haven’t Been Made for 120 Days
A loan is typically considered defaulted when payments haven’t been made for 120 days or more. A loan can default due to cash flow issues, an economic downturn, a shift in the market, or operational setbacks. Missing a few payments means the borrower is delinquent, not in default. In that situation, the lender will usually contact the borrower to try and work with them to cure the delinquency and bring the loan current. So, don’t sit on your hands. Be proactive. The worst thing you can do right now is sit still and hope the problem will go away. Borrowers in delinquency or default should immediately let the lender know about their situation and reason for the cash flow issue, if possible. If you can come up with a plan to cure the delinquency or default, then let the lender know. Let them know that you are committed to bringing the loan current and you have an action plan to do so. But don’t say you have an action plan, unless you have a plan.
There are three main options at this stage. The first is deferment (or forbearance), which is basically a temporary pause on your payments. This is usually short, up to 6 months, and you have to show it will help your cash flow so you can pick up the payments again. Restructuring, on the other hand, involves changing the loan terms – extending the repayment term, and/or modifying the interest rate. You can also offer an OIC (Offer in Compromise) – a lump sum to resolve the loan obligation. Lenders require extensive financial details from the borrower and guarantors, as well as liquidation of the collateral.
The Local Lender Issues a Demand Letter
If the loan does go into formal default, the local lender issues a demand letter, asking for immediate repayment of the loan. Generally, the lender will grant 30-45 days for the borrower to pay in full, depending on the loan’s terms. Next, the local lender will start to seize collateral, i.e. business bank accounts, accounts receivable, real estate, machinery, inventory, and equipment. For a lot of owners, this is the moment they realize that all the assets of the business are on the line.
Your lender may sue you, foreclosing on any real estate you have or after liquidating your collateral to collect the deficiency. In New York, judgments are enforceable for up to 20 years. The judgment can also become a lien on any other real estate you might own. At this point your lender will collect the guaranteed amount from the SBA. The rest of the debt is turned over to the SBA.
Direct SBA Loan
In a default on a direct SBA loan, the process is similar, but the SBA has stronger tools. The borrower must liquidate any collateral and turn the proceeds over to the SBA. Then, the SBA will consider an OIC based on the borrower’s hardship. An OIC allows you to settle for less than the full balance, but you must demonstrate that the business has closed down and liquidated and personal finances are bleak. In other words, there is simply no way to pay the loan back.
If you don’t succeed with an OIC, the government will kick in and use their collection tools, namely Treasury Offset Program (TOP) and/or Administrative Wage Garnishment (AWG). The TOP can take part of your federal wages or Social Security, as well as all of your vendor payments and tax refunds. AWG allows up to 15% of your disposable income (your net pay after deductions) to be garnished. Lenders and the SBA must sue within 6 years to obtain a judgment, but there is no statute of limitations with TOP or AWG. They continue until the debt is paid in full, including interest and collection fees.
If you file for bankruptcy, you can reorganize and cure the default while continuing to operate, or wipe out the debt if the business has closed down. Bankruptcy will stop collection efforts, including TOP and AWG.
It’s important to understand that defaulting on an SBA loan can have serious long-term financial consequences. No matter which path you’re on, my advice is do not run. Don’t just act scared. Don’t ignore the problem. This is a situation that requires action on your part. In default, be proactive and work with the lender (or SBA) to find a resolution. It might take time, but the outcome is crucial for your future financial stability.
In the end, dealing with a defaulted SBA loan comes down to choosing the right path – whether it’s restructuring, an OIC, or seeking legal and financial advice to navigate your situation. Whatever decision you make, the goal should be to find a solution that is both fair and sustainable, keeping in mind your business’s future and your personal financial health. Remember, while the situation is challenging, there are still ways forward, and it’s essential to explore them diligently.
