Financing takes many forms and is oftentimes needed to jumpstart a business or in order to keep it operational during a rough patch. Small business loans are one of the most accessible options, since they are often easier to get than other options (provided the borrower has a solid credit history and clean financial record). Paying one back is harder; it can be quite difficult if you’re already behind. That is especially true for borrowers with irregular business incomes, like a young company still finding its footing. The difference in income from month to month can make payment easier at some times and harder at other times, and when the payments stop, it can get real bad, real fast. An Equifax report from November 2023 found that small business loan delinquencies rose in nine of the 10 largest U.S. states. If your business is starting to miss payments, you need to understand what happens at every step of the way and where you draw the line.
Before an Account Reaches Default
Sometimes the terms “delinquent” and “default” are used interchangeably, but that’s not technically the case. These are two different things. Generally, a loan is not in default after one missed payment. If you miss a payment on a loan, that payment is late. You won’t technically default until you’ve missed multiple payments. Different loan products have their own norms around what constitutes default. That is why it pays to read your loan agreement carefully. It spells out when you will be in default based on your specific loan and lender, including how many missed payments, and which other actions, can put you there.
Before an account reaches default, it is usually considered delinquent. When you miss a single payment, a grace period begins, and depending on the lender it typically runs from 30 to 90 days. Once that grace period is over, the loan is delinquent, and it stays that way until you bring your account current again. The good news about delinquency is that it’s not yet a final call - there’s still time to get things back on track and avoid default. You can often fix it by making the missed payment and paying any late fees. But if you keep missing payments, there will be consequences. The more payments you miss, the higher your chance of a default. A default is a more severe situation.
Once a Loan Is in Default
A default will lower your business credit score. Just as with your personal credit, your business credit score is affected when you miss a loan payment. Payment history is the single biggest factor in that score, so missing payments could seriously tarnish your score. Your business may also be stuck with a default on your business credit report, which can make it hard to get financing in the future. Of course, a big credit score drop is just one risk.
Once a loan is in default, the consequences go beyond just your credit. Your lender may seek repayment of the balance, and how it goes about that depends on whether the loan was secured. If you put up business or personal property as collateral, that collateral may be seized by the lender if your small business loan is in default. If your loan wasn’t secured, the lender may sue you to try to collect. A default puts both the business and the lender in a difficult position.
If you have not defaulted yet but are struggling to keep up, contact your lender as soon as possible. Explain the situation and whether it is temporary. Do not wait until you are in default to try to get the lender to cooperate. Reach out to them directly to see if they’ll adjust your schedule to give you a more manageable repayment timeline. There may be other options available if you stay in touch. You don’t want to just hope things get better and hope that you can save yourself in the short term, you want to keep communication lines open so you have some degree of control over the situation.
Rebuilding Your Credit
If the default has already happened, don’t give up hope! You can recover from a small business loan default. Even though it will bring your credit score down and make it hard to get credit, you can recover. It will take some time, but you can work your way back from a default by making your payments and rebuilding your credit score. The key is to make every payment on time and in full, since payment history accounts for 35% of your credit score. Treat your existing debts like scheduled meetings that need to be kept. Put a reminder on your calendar for payments due, or even better, set up automatic payments to ensure you don’t miss them. Make sure those payments arrive on time, every time. If you do this consistently you’ll see an improvement. Make sure you know what your current credit score is so you can monitor how much it improves over time.
A default makes it harder to qualify for new business credit, but it doesn’t make it impossible. You might have to shop around a bit and find a lender who will work with you, but a default is not a death sentence. One option is a secured business credit card, which works like a normal credit card but requires a cash deposit that secures the credit line and offsets the risk to the issuer. Bank of America’s Business Advantage Unlimited Cash Rewards Secured card, for example, is meant for borrowers with low or no credit history and requires a minimum deposit of $1,000. The deposit serves as your line of credit until you’re able to improve your credit score enough to qualify for an unsecured card. You can use this secured card to rebuild your credit score by paying your balance on time every month. Because the card is backed by your own money, it lets you build healthy habits without sinking deeper into debt.
On the loan side, you may be able to find lenders that would look at your loan application holistically. For a business coming back from a default, the most helpful might be alternative lenders that do deal in secured loans and also base their underwriting decisions on other criteria. Greenbox Capital is one example. Instead of putting down a cash deposit, you secure the loan with an asset. An alternative lender like Greenbox will also evaluate other aspects of your business: revenue, cash flow, vendor payment history and years in business.
Be selective about when you go looking for new credit. A mix of open accounts can help your score, but opening too many new accounts or making too many inquiries can work against you and damage your credit even further. That’s why it’s best to apply only for what you need. Make sure enough money is coming in to cover new balances, because applying for credit when you can’t afford it puts you in an unnecessary debt cycle. Set a criteria of when you will apply for credit (and when you’ll not) so you don’t jump at every opportunity.
Missing one payment on a business loan will not usually put you in default right away. But it can lead to default if you keep missing payments. It is crucial for borrowers to communicate with their lenders and seek assistance if they are unable to make their loan payments to avoid the consequences of default. The last thing you should know is that credit will take a while to come back from a default. A business loan default is a damaging event, but if you’re quick to repair the damage you can come out on the other side stronger.
