Why You Shouldn’t Default On A Business Loan (& How You Can Avoid It)

Defaulting on a business loan could result in damaged credit and difficulty finding funding in the future. Here's how to avoid default.

WRITTEN & RESEARCHED BY
Kymberlin Bush
Expert Contributor

Last updated onUpdated August 18, 2024

REVIEWED BY

Editor & Senior Staff Writer

Our content reflects the editorial opinions of our experts. While our site makes money through , we only partner with companies that meet our standards for quality, as outlined in our independent .

Key Takeaways

If you're worried about defaulting on a loan, contact your lender as soon as possible. They may offer temporary relief or a revised payment plan to help you get back on track
Refinancing your loan can extend your repayment terms and lower your monthly payments, making it easier to manage your debt.
Focus on paying off debts that are critical to keeping your business in operation or loans that are secured by collateral first before tackling less urgent debts.

Are you worried that you are going to default on a business loan?

Miscalculations, sudden hardship, declining sales, or any number of other things could end up with you struggling to repay your business loan. Don’t panic yet! There are several options for you.

Read on to learn about what happens when you default on a business loan, what you can do to make sure that it doesn’t happen, and how to get back into good standing if it does.

Table of Contents

What Happens If You Default On A Small Business Loan
What To Do If You’re In Danger Of Defaulting On Your Loan
Defaulting On A Small Business Loan: Final Thoughts

What Happens If You Default On A Small Business Loan

If you miss a payment, your lender will most likely charge a late fee, an insufficient funds fee, or both. Try to avoid missing payments because even one or two missed payments can affect your credit.

If you can’t get back on track, your business loan will enter default status. Most lenders will give you a two-week grace period, but this varies from lender to lender. Default status means the lender is assuming that you’re not intending to make your loan payments, and they’ll move forward with taking the necessary steps to get their money back.

If Your Loan Has Collateral

Remember that asset you put up as collateral when you got your secured loan? That was done to lower the risk to your lender when they made the loan. If you default, your lender will most likely invoke the lien they placed on your collateral and repossess it. They can do this without taking you to court.

Now, if you really don’t want to part with the item, keep in mind that your lender will probably give you an opportunity to make the missed payments and bring your loan out of default status.

If You Signed A Personal Guarantee

If you got an unsecured loan, meaning that you didn’t put up any explicit collateral, then you probably signed a personal guarantee or a UCC-1 blanket lien. These agreements serve as a kind of collateral, but they’re a lot harder to enforce. A personal guarantee allows the lender to go after your personal assets in the event that you default. A UCC-1 blanket lien lets them liquidate your business assets.

Some personal guarantees have limitations written into them concerning what the lender can go after and how much they can take. These agreements tend to be full of legalese and are difficult to parse for the average person. One of the following three scenarios will then likely happen:

If the amount of debt you still owe is relatively minor, the lender might take you to small claims court. Small claims court is used to expedite disputes over a small amount of money, so it’s a fairly easy process. A lender can sue if the amount of outstanding debt is somewhere between $3K and $10K, but the maximum amount varies by state.
If the lender suspects that you have enough money but you don’t want to pay off your loan (remember: most lenders have read-only access to your bank account), they might take you to court.
If the amount is more than the limit imposed by the small claims court and the lender doesn’t think you can pay, they might just let you off the hook.

If You Have An SBA Loan

As a more complex type of loan, you won’t be surprised to find that defaulting on an SBA loan is a more complicated process. Once your SBA loan enters default, expect the lending bank to seize any collateral you’ve put up like they would within a secured loan. If you put up both business and personal collateral, the business collateral will be collected first, then your personal guarantee will be invoked.

If the loan still isn’t paid in full after that, the lender will file with the SBA for the SBA-guaranteed portion of the loan. At that point, you can expect correspondence from the SBA in the form of a 60-day demand letter. If you fail to respond, your case will be turned over to the Treasury Department. If you can’t pay the amount the SBA guaranteed, you’ll have to work out “an offer of compromise” with the agency and try to demonstrate that you’re in need of clemency.

Keep in mind that the Treasury Department has a lot more powers than a collection agency does and can do things like withhold your tax refunds and garnish your wages, so you’re better off cooperating with the SBA if you can.

What To Do If You’re In Danger Of Defaulting On Your Loan

If you’re struggling to repay your debts, here are some things you can do.

Contact Your Lender

Chances are your lender doesn’t want you to default. Selling off your collateral is time-consuming. Taking you to court is expensive. Selling your debt to collections means taking a hit to their bottom line.

If you contact your lender and let them know you’re suffering from a temporary setback but will still be able to repay the loan, your lender might be willing to temporarily reduce payments or work out a better payment schedule. After all, your lender wants their money back. This should be done as soon as possible; the lending company can’t help you if you don’t communicate with them.

Refinance Your Loan

Drowning in short-term debt? You’re not the only one. Short-term debt can very easily kill a business’s momentum. Fortunately, this is a common problem, so there are a number of lenders available that specialize in refinancing debt. These companies will normally offer you longer loan terms with smaller bi-weekly or monthly payments, which are much easier for businesses to handle.

This is another step you’ll want to take as soon as possible: most companies require a credit score of at least 600, though some go lower. You’ll want to do this before your lender reports late payments to the credit agencies.

Prioritize Your Debts

Businesses have a lot of money going in and out. Most of the money going out is necessary to keep your business running smoothly, but some debt is more important than others. Take stock of what debt is most likely to impact your business’s ability to run, and take care of that first.

Any debt in which the lender has a UCC-1 blanket lien on your assets is very pertinent. If you happen to have multiple liens, the oldest loan is the most important; that lender holds the first position, which means they have first dibs on your collateral if you default.

Other important debt includes anything you have to pay to keep your business running smoothly. This includes things like rent and utilities. Loans secured by collateral might also go in this category if the collateral is integral to the operations of your business.

On the other hand, unsecured loans (like credit cards) fall on the less important end of the spectrum. While leaving this debt unpaid can and will carry consequences, it’s unlikely to interrupt the running of your business.

Seek Legal Help

If you can’t find any other way out of defaulting on your loans, you might want to seek legal assistance. A lawyer can help you understand what rights you have in your specific situation.

Defaulting On A Small Business Loan: Final Thoughts

If you’ve done all this work to secure getting one of the best business loans available, defaulting on your business loans is something that should be avoided if at all possible.

If you’re struggling to repay your loans, the worst thing you can do is nothing. Keep in mind that a default is usually a lose-lose situation for both you and your lender, so be sure to communicate with them about your financial condition before the default process begins.