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A business loan can be a lifeline, giving your business the capital it needs to weather the storm or lean into a growth opportunity. It does mean taking on debt, though. And if you can’t make payments to the lender on the agreed-upon schedule, you’ll face a business loan default.
The consequences of business loan default can be far-reaching, even impacting your personal finances. So before taking out a small business loan, ensure you understand how to avoid default.
What is business loan default?
When you default on a business loan, it means you’ve missed payments for long enough that your lender takes action. You generally won’t default on a business loan after one missed payment, but from that day forward, the clock starts ticking.
Once you reach default, things get serious. The consequences of a business loan default can include:
- An accelerated balance
- Legal action
- Added late payment fees
- The seizure of any collateral you put up for the loan
- The seizure of personal assets if you made a personal guarantee on the loan
- A big business credit score hit
- A big personal credit score hit if you used your personal score to get the loan
When the lender accelerates your loan, you don’t just owe the outstanding monthly payments, accrued interest and applicable fees. Instead, as of that date, you owe the full loan balance back to the lender.
Default vs. delinquency
Default happens when you miss payments on your business loan — but not immediately. First, your lender considers your loan delinquent. They’ll generally reach out to notify you of the missed payment and find out if there’s a reason for it.
If you missed a payment or two because you forgot, you can fix delinquency by paying back what you owe plus any accrued fees and interest. Depending on your loan terms, your business credit score — and possibly your personal one — will still take a hit. But it will be a relatively small dip compared to the serious credit ramifications of a business loan default.
If you continue missing payments for a period of time specified in your loan terms (usually 3 to 6 months), you enter default. To avoid this and the ramifications — from the seizure of your assets to less favorable bad credit business loans — do your best to make payments by the due date.
Even if you can’t pay the full amount, a smaller payment shows the lender that you’re making an effort. And that can help you avoid moving from delinquency to full-blown business loan default.
How to avoid defaulting on a business loan
First things first, you need to stay on top of your company’s finances. Make sure you always have sufficient cash flow to cover your loan payments along with other expenses. Setting a recurring calendar reminder for a few days before your loan payment due date can give you time to check your account balance and ensure you have the funds to cover the payment. Setting up autopay is also a good idea so you don’t forget to send your lender the money.
From there, if you know you might miss a payment, you should start taking action.
Talk with you lender
Most lenders want to work with borrowers to avoid default. Going through collections or legal action to get what you owe costs them money, so they generally want to avoid it.
So contact your lender before you miss your first payment. Explain what’s going on with your business that’s making it impossible for you to pay.
You won’t be the first person to face delinquency — and possible default — with a lender. They may have options you can explore.
Refinance your business loan
As inflation cools, interest rates on business loans should decrease. That may make refinancing your business loan appealing. You might get added benefit if you have multiple forms of business debt to consolidate into one loan.
Even if the rates offered are virtually the same, extending the loan repayment term with a refinance can buy you some breathing room by bringing your monthly payment down.
Remember, the lender doesn’t want you to default, either. Talk with them to find out what plans they offer. This could include debt rescheduling, which might include:
- Making interest-only payments for a period of time
- Extending the loan’s repayment period
- Deferring interest for a time
- Deferring a certain amount of payments in general
- A lump-sum amount you pay to settle the loan
As part of this process, they may ask to see your business books or other details. Give them all the necessary information to see if you can arrive at a new plan that works for everyone.
Get help from a debt professional
You don’t have to navigate a potential default on a business loan alone. Some resources you can loop in include:
- A debt counselor. Through the National Foundation for Credit Counseling (NFCC), you can partner with an expert who can work with your lender to help you consolidate your debt, agree upon a debt rescheduling plan or settle your debt. Debt counselors offer expertise specifically tailored to help business owners avoid default.
- An accountant. Nearing business loan default means your company’s finances aren’t in order. Getting a professional on board to look at your books can help you explore options, from cost-cutting measures to tax savings. Just as importantly, it means you’ll have someone to help you budget, avoiding future missed payments.
- A bankruptcy attorney. If these other professionals can’t help you, and your lender can’t offer a realistic option, don’t go into bankruptcy without good legal counsel.
When you default on a business loan, you put your company — and potentially yourself — in a compromising financial situation. Depending on your loan terms, things can get serious fast.
Plus, even if you can weather the business loan default, the credit ramifications will mean you’re limited to the few types of bad credit business loans available today. And getting approved for them generally isn’t easy.
To avoid all of these potential challenges for your business, do everything you can to avoid a business loan default.
Frequently asked questions
Your limited liability corporation (LLC) might protect some of your personal assets, but only if you didn’t put them up as collateral or sign a personal guarantee for the loan. The good news is that as with any other type of company, the lender would rather you repay the LLC loan than default, so they should be willing to work with you. Ultimately, to avoid asset seizure, credit score dings and more, you want to be diligent in managing your LLC loan. Don’t assume your entity type will protect you if you default.
If you operate your business as a sole proprietorship or are a general partner in a partnership, you can be held personally liable for a business loan. Even if you operate your business as a separate entity, you might be liable, especially if you made a personal guarantee on the loan, which makes you personally liable for your business loan. Fail to pay it off and any personal assets you put up as collateral may be seized if your loan defaults. Missed business tax payments and failing to maintain your entity status also heighten your personal exposure during a business loan default.
It can, especially if you’re operating as a sole proprietorship. Even if you’re not, if you used your personal credit score as a factor to secure the loan, defaulting on the loan will likely have ramifications for that score. Check your loan terms to find if your personal credit standing is on the line.