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- Defaulting on an unsecured loan can impact your business and personal finances
- When you default on an unsecured loan, the entire loan becomes due immediately
- Your lender may be able to help you find a solution and avoid default
For many entrepreneurs, unforeseen circumstances often lead to missed payments or defaulting on the loan entirely. According to the 2022 Small Business Credit Survey, 32 percent of small businesses had difficulties repaying their debts.
When this happens with a secured loan backed by collateral, the lender can take the collateral as payment. However, with unsecured loans, there is no collateral backing the loan, so not repaying an unsecured loan can be far more damaging to both your business and personal finances.
Here is what can happen if you don’t pay an unsecured business loan and steps to take if you’re struggling with an unsecured loan.
What happens if you miss business loan payments?
Missing payments on a business loan is never a good idea. The initial consequence is accruing late fees, making your financial situation more challenging. Plus, the loan becomes delinquent once you fail to pay on the loan’s due date.
If you continue to miss payments, expect to hear from the lender’s collections department. Leslie Tayne, founder of Tayne Law Group, a New York-based debt relief law firm, notes that after a month or two, you’ll begin to receive calls and letters “in an effort to get the account back in good standing.”
What happens if you default on a business loan?
After multiple months of not making loan payments, the loan status will typically shift from being delinquent to being in default.
“This means you’ve failed to repay the loan according to the contract terms,” says Tayne, “at which point the lender will start taking more aggressive steps to collect the debt.”
Your entire loan becomes due
When a loan is in default, it may trigger what’s known as an acceleration clause in your loan contract.
“The acceleration clause provision states that the entire loan balance becomes due immediately if the borrower fails to uphold certain requirements, such as making timely payments,” says Tayne.
Plus, if the lender sends the debt to a collection agency, you may also be hit with collection fees. And worse yet, the lender can also initiate legal action against your company at this juncture, suing you for unpaid debts, which will cause you to incur court costs and potentially attorney’s fees as well.
Your personal assets could be seized
Unsecured loans are not backed by an asset or collateral, but that doesn’t mean a lender is without recourse. Often when providing this type of financing, lenders require borrowers to sign a personal guarantee. This type of legal promise allows lenders to offset their risk and means you’re personally liable if your business defaults on the debt.
“Usually, a business owner’s personal assets are protected from any financial issues related to the business. That’s not the case with a personal guarantee, however,” says Tayne. “This agreement allows the lender to go after a borrower’s personal assets if the company can’t satisfy the debt, including bank accounts, real estate and vehicles.”
Many traditional and online lenders and SBA loans require personal guarantees for unsecured loans. These lenders will expect you to use your personal funds to maintain a business loan if need be. And if you can’t, the lenders may initiate legal proceedings.
Your credit score and report will be impacted
Defaulting on a business loan is not just bad for your immediate finances. Your business credit score and, potentially, your personal score will take a hit.
Once a loan is over 30 days past due, the lender may report the delinquency to credit bureaus. When that happens, Tayne notes that it will be more difficult to obtain loans and lines of credit in the future since “missed loan payments and defaults stay on your credit reports for seven years.
What to do if you can’t pay an unsecured business loan
If your business is facing financial hardship making it difficult to repay a loan as agreed, it’s important to be proactive and try to find a resolution that helps avoid severe consequences.
Talk to your lender
When you can’t afford to make business loan payments, it’s important to reach out to the lender as soon as you think there’s a problem. The best unsecured business loans come from lenders willing to offer some assistance. This may include restructuring your loan, offering deferment or forbearance or refinancing the debt.
But ignoring the problem and letting your loan payments slide and become delinquent will only result in harsher consequences that will be more difficult to reverse or resolve.
Take out a debt consolidation loan
Taking out a debt consolidation loan is another option that can help you recover. Like small business loan refinancing, you are taking out a new loan, but since consolidation involves replacing existing loans with a single new loan, it may be the better option if you have multiple business loans. Ideally, through debt consolidation, you can obtain lower monthly payments or shorten your repayment timeline, or in some cases, both.
You typically need good credit to obtain the lowest, most favorable interest rates on a consolidation loan. You’ll also need to have a plan in place to help you manage your loan. As Tayne notes, “If you don’t address the underlying issue causing you to fall behind on loan payments, taking on a new loan that you can’t afford to repay won’t help your situation in the end.”
Restructure your debt
When you restructure your debt, you change the terms of your loan. This means you may be able to extend the payment period, which will lower your monthly payments. Or you may be able to negotiate a lower interest rate. This is a good option when you’re behind on payments, and it’s clear that there is no way you’ll be able to catch up and repay the past due balance and continue making payments.
Should I file for bankruptcy?
Filing for bankruptcy should be your last resort, as this step has serious consequences, including being costly, time-consuming and impacting your credit for years to come.
The three most common forms of bankruptcy filings are Chapter 7, Chapter 11 and Chapter 13.
|Chapter 7||Businesses intending to close and will no longer need the assets that will be sold.||A business sells its assets to generate the money needed to pay creditors. This process is typically quick, often taking six months or even less.|
|Chapter 11||Businesses intending to stay open and would like to retain assets.||Business reorganizes and restructures debt and comes up with a plan to repay the debts. This option is a more complicated type of bankruptcy filing and can be more costly.|
|Chapter 13||Businesses intending to remain open and retain assets.||Business reorganizes and restructures debt, paying some creditors back in full while others receive a percentage of the debt owed. Requires a regular income to repay the debts.|
Filing for bankruptcy can have pros and cons. Taking this step can provide the fresh start that you may need to get a handle on your debt and recover financially. But the drawbacks include liquidating assets, depending on the type of bankruptcy you pursue, and impacting your credit. There are also debt limits under Chapter 11 and 13 bankruptcies, which restrict those eligible to pursue them.
Note that bankruptcy filings stay on your credit report for up to 10 years. The filing process can also be costly, and bankruptcy repayment plans often take years to complete.
If unexpected circumstances arise and you can’t repay an unsecured loan, it’s important to be proactive. If you fail to take action and continue to miss loan payments, the ramifications include the loan being called due, assets being seized and your credit score taking a nosedive. But you can avoid these outcomes by pursuing some options, including reaching out to your lender to discuss your situation, seeking debt settlement, or applying for a debt consolidation loan.
Frequently asked questions
In some cases, a business loan may be forgiven. But this is rare and only occurs when it’s clear that you do not have the means to repay the debt.
In most cases, the lender will use all the tools at their disposal, including a lawsuit, to collect that debt.
In the case of SBA loans, you might be able to get a portion of your debt canceled through what’s known as an offer in compromise (OIC). This process involves explaining the circumstances preventing you from repaying the loan and offering a lump sum settlement for less than what you owe. If the lender accepts your offer, the account is closed.
Typically, your loan contract outlines your rights as a borrower and the consequences of defaulting on a loan. If you signed a personal guarantee, the lender could come after your personal assets. In some cases, the lender may allow you to defer or renegotiate payments.
Both delinquency and default mean you are behind on your loan payments. A business loan delinquency occurs once you fail to make a payment on the loan’s due date. Business loan default typically happens after a few months of missed payments.