Most businesses experience financial difficulties at some point and, fortunately, they usually find ways to get back on track. But what if you can’t find your financial footing?
In this overview, you’ll learn what a business loan default is, how to avoid it, and what happens if you default on a business loan. There are important implications for a business loan default, so before we dig deeper, know this: If you ever find yourself in the kind of financial distress that may trigger a default, please contact your lender – we want to help.
What is a business loan default?
When you borrow money for your business, you agree to the repayment terms specified by the lender – and that’s true whether the lender is a bank, a credit union, a Community Development Financial Institution (CDFI), or a family member.
And if you don’t repay the funds as agreed, that, in a nutshell, is a business loan default.
Although this varies, most responsible lenders won’t consider a loan in default if they receive a late payment now and then. However, regular late payments could hurt your business, your personal credit, and your ability to secure future funding with the lender. Unless you stop making payments altogether, your loan is not likely to go into default.
When a borrower defaults on a loan, a lender can claim the collateral that was pledged to secure the loan and/or take other steps to reduce losses. This means that in addition to business assets, if you secured a loan with personal assets such as your home, car, or boat, for example, these could all be at risk.
Is delinquency different than default?
Yes, being delinquent on a business loan is different than being in default, but it’s also often a “red flag” to lenders that your business is experiencing financial difficulties. Here’s why your lender will pay attention if you’re delinquent and why you should, too:
- Delinquency happens when you’re late or miss a scheduled payment. While this can be an innocent and rare occurrence (you thought a payment had already been made, for example), it can also be a tactic that business owners use when they’re short on cash. Because delinquencies typically lead to default, lenders take delinquencies seriously.
A loan is typically considered delinquent the day after a payment is missed and continues until the payment is made. Delinquencies are usually reported to credit bureaus once they exceed the 30-day mark, although some lenders may pull the negative report when you catch up on your missed payments. Even if a delinquency stays on your credit report, as long as you make subsequent payments on time and in full as agreed, the impact will decrease over time.
- A default is declared when you miss several payments and don’t contact your lender to work out a plan. At this point, the lender has determined that you’re unlikely to repay the loan.
Under normal circumstances, most responsible lenders won’t declare a loan in default based on the first or even second missed payment. Instead, there’s usually a specified period (90 days, for example, without payment) outlined in your loan agreement. After this period, your loan would be in default.
This is why it’s so important to stay in contact with your lender, especially if you’re having difficulty paying your loan as agreed. It can save you from further financial difficulties and legal issues, and from potentially losing your business. After all, you can’t run a restaurant if your lender has had to reclaim your kitchen equipment.
Do lenders want to declare a default?
The fact is that lenders are in the business of money, not reselling restaurant equipment or real estate. Reputable lenders would rather work out a solution when you’re not able to repay your loan.
Given this, it’s significant when a lender determines that your loan is in default. It triggers a series of actions to recover at least some of what’s owed, whether as cash or collateral. The actions a lender can take include but may not be limited to:
- Seizure of collateral: If the business loan was secured debt, and most are, at least partially, then your lender can seize the collateral that was pledged to recover what you owe. This could mean losing key business assets, such as equipment, inventory, or property.
If personal assets, like your home or car, were used to secure the loan, then the lender can claim these, too. This happens more often to businesses that are structured as sole proprietorships or partnerships because these entities don’t shield personal assets from business liability.
- Negative reports to credit-reporting agencies: Business loan defaults are reported to credit bureaus and will negatively impact your credit score. This makes it more difficult to get future financing for you and your business. It will also have a significant impact on the terms you’re offered, including the amount you can eventually borrow, the interest rate, and the repayment term.
- Legal actions and lawsuits: If you default on a loan, your lender may take legal action to recover the outstanding debt. This can include filing a lawsuit, which could lead to a court judgment against the business. Keep in mind, too, that legal proceedings can be expensive and you may need to pay for your lender’s legal representation and related costs, as well as your own.
How to avoid business loan default
Avoid a business loan default starts from the moment that you start exploring business loan options. There are steps you can take to help you avoid business loan default:
- Know the terms of any loan that you’re considering: Before you accept a loan, be sure that you understand the repayment schedule and that your business has enough cash flow to make payments as agreed.
For example, if you work with a lender who expects weekly payments and you’re making them monthly, then even if you pay the full amount, you could technically be in default.
You also need to know what may trigger a default. In some cases, missing just one or two payments may be enough. Most reputable lenders consider a loan in default only after several payments are missed within a specific time period. - Monitor your business’s cash flow and revenue cycles: Many businesses have natural cycles that impact cash flow, and as the owner, it’s up to you to understand yours and plan ahead. For example, if your revenue tends to be much higher earlier in the month (or if you have fewer bills due then), ask your lender if you can adjust your payment date accordingly. And if you find yourself unexpectedly short on cash, rather than skipping or shorting a payment, contact your lender to learn about options they can offer that can help you.
- Restructure existing debt: If you’re struggling to make loan payments, it could be that you’re tied into high-cost debt, your loan comes with difficult terms (like weekly or even daily payments), or other challenges. If that’s the case, your lender may have options that can make it easier to repay your loan. You can also explore other lenders that could refinance your loan into one that’s more manageable for you.
Talk to your lender to see if better terms are available. That may mean extending your loan term, reducing your interest rate, or negotiating a temporary reduction in payments. It’s a conversation worth having and it can save your business. - Seek professional advice: If your business is continuously struggling, talk to your accountant, financial advisors, and business mentors for insight. If you don’t currently have any mentors, try reaching out to your local SCORE or Small Business Development Center (SBDC) for free or low-cost support. They may be able to work with you to find opportunities to build revenue and profitability, reduce expenses that you’re overlooking, or have other advice to get your business back on track.
- Communicate with lenders: It bears repeating: open communication you’re your lender is crucial, especially if you’re facing financial difficulties. Informing lenders about potential problems before they escalate can lead to solutions.
Business loan default FAQs
Q: If my business is having financial difficulties but I haven’t been late on payments yet, what should I do?
A: This takes some business soul-searching: Is it the low point of your business cycle that will be resolved soon? If so, then you may simply need some additional working capital to help you through the lean times. Have you taken on unnecessary expenses, or are you offering products and services that aren’t generating revenue and profits? If so, you may need to trim down anything that’s not building your business’s financial strength.
Q: What steps should I take if I’ve already been delinquent and think I might default?
A: Contact your lender to review your situation and discuss potential solutions.
Q: Can a business loan default be reversed?
A: That depends on your lender’s policies and your specific circumstances. In some cases, renegotiating or restructuring your loan might be possible. In other cases, your lender may see no other option or determine that it’s too late to pull back the default.
Q: How long will a default impact my business’s credit rating?
A: Defaults can remain for several years, impacting your ability to secure future financing. For small business owners, this will impact any business credit you may have been building.
Q: Does a business loan default affect my personal credit?
A: It certainly could. In such cases, the default can be reported on your personal credit report and negatively impact your personal credit score, based on the loan agreement and your business structure.
Q: Are there alternatives to defaulting if I’m struggling with my loan repayments?
A: Yes! When you contact your lender, in addition to working out a payment plan for your current loan, ask if they have any options for helping you refinance to a lower-cost loan. It could be a loan with a lower interest rate or a longer repayment term (or, better yet, both). If they don’t have anything available, be sure to make your payments as agreed, then continue to explore options available through another lender.
Responsible lenders can be an ally when your business is struggling
Every day, Pursuit works with small business owners like you to get the financing you need for success. If you’re in New York, New Jersey, Connecticut, or Pennsylvania, take a look at our 15+ loan options and a line of credit, then contact us to learn more.
