Small businesses have been relying heavily on the support of the SBA, especially during the COVID-19 pandemic. The most common form of support the SBA offers is financial in the form of loans. Before the pandemic, however, an SBA loan was difficult to come by as there were strict rules in regards to who was eligible for an SBA loan and the necessary documentation. During the pandemic, the SBA was overseeing a lot of programs such as the Economic Injury Disaster Loan (EIDL) and the Paycheck Protection Program (PPP). Because of the urgency and need to get money to small businesses, SBA has made the process to apply for a loan much easier, and subsequently, obtaining an SBA loan became much more widespread. With the economic uncertainty surrounding the pandemic, many small businesses are struggling to continue and owners can no longer pay back the loans they took out and are defaulting. This article will discuss what that means, its potential effects, and ways to respond.
Being “Delinquent” and “Defaulted”
There’s a difference between being “delinquent” and “defaulted.” The next steps will vary based on your status. An SBA loan is considered “delinquent” if you have missed one or more payments, and the lender still expects to receive some or all of what it is owed. It is in default when the lender has determined your business will be unable to repay. Who decides? If the SBA is lending directly to you, it makes the determination of whether you are delinquent or defaulted. Generally, however, the SBA works through banks and other financial institutions, guaranteeing the loan (to keep the bank’s risk down); in this case, the bank (probably yours) will make the determination.
No one wants to be delinquent, but there are ways to handle it. The lender or the SBA writes to the borrower, notifying the borrower of his/her delinquency and demanding prompt payment. Procedure differs among lenders. Typically the lender will levy a late fee and contact the borrower to discuss the repayment. The borrower may explain the circumstances leading to the missed payment. The lender may then restructure the terms of the loan or come up with some other means to satisfy the debt. The lesson: let the lender know as soon as you think you’ll miss a payment, and the sooner you reach out to ask for help the better the chances of finding a reasonable solution.
When you do talk, let them know you can’t pay, and be honest. The lender wants repayment of the loan, so it may be willing to consider a longer term with a reduced monthly payment, suggest that you analyze your cash flow and expenses to see where you can create payment funds, or permit interest-only payments while you take a hard look at your business finances. The lender likely expects a payment of some sort within 30 days of its contact; always pay something.
Timing matters, too. Depending on how quickly the borrower repays or whether they pay at all, missed payments may be reported as “late” on the business or personal credit report. Multiple missed payments also will be reported as additional derogatory marks. If the borrower continues to fail to make the required payments for a certain period (usually 90-120 days), the loan will be declared in default. These derogatory marks will reduce the credit score, and may also affect the borrower’s ability to obtain new financing.
The Loan Goes into Default
If you keep missing payments and cannot reach a workable plan with your bank or the SBA, the loan goes into default. If you have defaulted on an SBA loan, you are probably in a tight spot. To start with, any of the collateral you put up (whether a business asset or personal asset) can be repossessed by the lender and sold to pay off at least part of the amount. Same with any third parties who guarantee the loan. Their assets can also be repossessed and sold. The SBA will also get involved in collection - if they’re not already - by sending out a demand letter. If the business or individual doesn’t pay off the loan after a certain amount of time, the SBA will look at the business (or personal) financials to see if there are funds to be recovered. If there are, they can get the ball rolling in legal action. Finally, of course, business and personal credit histories will reflect the loan default.
This can be a frightening prospect, but there are options for you to consider. You should make at least some payment on the loan, to show that you’re making an effort to settle the debt. Be prepared to respond to a lawsuit or the garnishment of your business income by the SBA for repayment of the loan. However, if you truly can’t pay the loan back in full, you may submit an Offer in Compromise form (OIC) to an SBA Loan Officer. This form will request detailed financial information and the amount that you can afford to pay. Give a copy of the Offer in Compromise to the lender and the SBA. If accepted, they will schedule a date for final payment, and the loan is then closed.
Avoid Default
If you have not reached that point yet, there are ways to avoid default if you are in financial trouble. Get a grip on cash flow. Prepare an emergency budget, paying the SBA loan first and reducing owner draws and other, less important expenses. Cut fixed expenses wherever possible and reduce variable expenses to the bare minimum. If you think you won’t be able to make your payments, give your lender (and SBA) a heads up as soon as possible. Keep meticulous records of business and personal money. Look into consolidating other business loans on more favorable terms so you can put the savings toward your SBA loan. Speak with an accountant or a business lawyer about your situation and staying on top of things.
If a business can’t make its monthly payments, it should first contact the lender and explain the situation. The earlier you do it, the better your chance to make an agreement before things get worse.
