You missed a monthly payment. You’re worried you can’t make the next one. This is pretty serious but don’t panic. There are a series of events that kick in when you stop making loan payments: delinquency, default, collection, seizure of collateral, and/or seizure of your personal assets if you signed a personal guarantee. If your loan is SBA-backed, the process involves the SBA then the U.S. Treasury Department. When you understand the process, it leads you to the choices you have, and how to make them.
Delinquency and Default
A delinquent loan is one in which a payment has been missed or is late, even by one day. (The lender may, depending on the loan agreement, apply a late fee or penalty.) In other words, it’s one payment down. We’re not in default land yet, but we are well and truly in trouble. At some point a delinquent loan becomes a loan that’s in default. What is default? Default happens when the borrower repeatedly fails to meet the legal conditions of the loan. Once a loan falls behind, it usually takes between 90 and 120 days before a lender declares the loan in default. Both delinquency and default put a major dent in your credit score, of course. If not resolved quickly, a delinquency can easily turn into default.
The lender looks at your loan agreement and reviews the standard collection rules for when a loan is in default. They start contacting you by phone and email. Many of the federal consumer debt collection protections do not apply to business loans, though some states have specific communication laws regarding collection, and some lenders have their own communication rules. The key here is to communicate with your lender. Don’t avoid them; just the opposite: respond to calls, letters, and emails promptly. Otherwise it will only make things worse.
The lender can seize any collateral you used to back the loan. If your business has failed and you have no business assets left to repay the debt, the lender can invoke your personal guarantee. It may also force you to sell assets or even obtain a court order that requires the release of funds from your business accounts.
SBA Guarantee
If your loan carries an SBA guarantee, there is a second act to this story. The lender files with the SBA for the guaranteed portion of the loan (minus the amount collected by other means) when you don’t pay the loan. The second act begins with the SBA reimbursing the lender. That does not mean the problem is over. The SBA will still contact you to collect the money according to the terms of your loan agreement. That contact comes as a 60-day demand letter, which warns you that your case will be turned over to the U.S. Department of the Treasury unless you respond within 60 days.
If you have been unable to repay the SBA, you can put together an offer in compromise, which is an offer to settle your debt for a lump sum less than what you owe or a payment plan. First, you have to prove that you’re unable to repay the SBA within 60 days. Your proof should include tax returns, business and personal asset documentation, income statements and expense reports. If you’re able to demonstrate you can’t repay, the SBA might agree to your offer, even if it’s less than you owe.
After sending a 60-day demand letter, and getting no response or having the offer in compromise rejected, SBA may refer you to Treasury for collection action. And when you’re in Treasury’s clutches, the hardball really starts. The Treasury may garnish your wages, withhold your future tax refunds, or file a lawsuit in civil court. If the debt is not paid by the deadline, it may come after you with a vengeance. You can still attempt to settle with Treasury, but it’s not easy. Much easier to work with SBA long before your case lands there.
Avoiding Default
Now, the “universal” first step to avoiding default is simple: Pay your loan on time and follow all the legal requirements. Simple but not necessarily easy. If you can’t, review your finances in an attempt to find expenses that can be cut, freeing up more funds to be used on your loan payment. You may have more flexibility in budgeting than you think. Then run a cash flow forecast. This is not an exact calculation, but it can give you a peek into your near-future finances. If the forecast predicts a cash flow problem, you’ll have time to make changes to your business now to avoid defaulting on your loan.
Call your lender. It’s better to speak up about your financial situation now, rather than having it become a bigger problem later. Open communication with your lender may be your first step to finding a new solution to a temporary financial issue. In fact, the lender may help you create a new, more feasible loan payment plan, or even reduce the total cost of the loan. (SBA partner lenders almost always want to find ways to work out payments; they lose money on defaults.) An alternative payment plan will be mostly to the lender’s advantage. But, it’s still probably better than defaulting.
The last option is to hire a professional. Not the most cost-effective option by a long shot, but one that may be your best course of action if your business is truly at risk of default. Your Certified Public Accountant can help you sort through your financial situation, identify areas where you can reduce costs, and find ways to continue to make loan payments. If the situation has already worsened to delinquency or default, the next move may be to hire an attorney to help. An attorney can help negotiate your terms with the lender and the SBA. An attorney can help draft an offer in compromise.
Above all, please remember: defaulting on a loan is serious, but it does not mean the end of the world. It is stressful, but you can recover financially once the debt is settled. Do whatever you can to avoid defaulting, keep communication open, and keep working to improve the financial health of your business.
