By Meredith Wood, Fundera
There are countless reasons why a small business owner might take out a business loan. From stocking up on inventory for your store to purchasing expensive equipment necessary to run your business, it’s not unusual to require a little extra capital to make ends meet.
Of course, when you take out that loan, you have every intention of paying it back. But sometimes life has other plans. Broken equipment, a high utility bill, an outstanding invoice, or a general downswing in the market are just a few of the unexpected challenges that can cause business owners to miss a payment on their loan.
Fortunately, more often than not, you can quickly make up the late payment and get your business back on track.
Lenders don’t like surprises, so if you know you can’t make your next loan payment, it’s essential to reach out to your lender. Some lenders may be willing to work with you, whether that means allowing for partial payment, extending your due date, or even pausing your payments until your business is back on track.
Preparing your lender in advance of missing a payment will give you more time and flexibility to figure out a solution that won’t leave you (or your lender) in the lurch.
In general, loan delinquency is defined as a single late or missed payment, while a loan in default is defined as missing several payments over a period of time. However, whether your small business loan is considered delinquent or in default depends entirely on your specific lender and the lender’s policy. Your lender may reach out immediately after your first missed loan payment, or wait until you’ve missed several payments in a row – either way, expect to hear from them.
Unsurprisingly, your lender will want to know why you missed your loan payment and – depending on the lender – will offer various options to get you back on track. Different lenders will offer different solutions when you miss a loan payment, but some such solutions may include a short, penalty-free grace period for making up the missed payment. The lender may even offer to renegotiate the terms of your contract.
Whatever the solution may be, you can bet your business lender will want to help you get your loan payments back on schedule.
If you’ve fallen into unfortunate circumstances where you simply cannot pay back your loan, what happens next depends on whether you have an unsecured or a secured business loan. A secured business loan is backed by physical or financial assets as collateral, such as a house, a car, equipment, jewelry, or a savings account, while an unsecured loan is not backed by any kind of collateral.
When a secured business loan goes into default, depending on the exact terms of your agreement, your lender will be able to seize whatever assets you offered as collateral on your loan in order to recover the losses.
For example, if you put up your business equipment as collateral for your loan, and then defaulted on that loan, your lender would be able to seize that equipment in place of the monetary payments you would have been making.
With an unsecured business loan, while you haven’t specifically assigned your assets as collateral for your loan, your lender will still go through a collections process to recoup losses. Your lender may sue your business to collect on the loan, and is allowed to seek compensation not only for the outstanding balance of the loan, but also for interest, penalties, fees, and costs.
Borrowers of unsecured business loans should also take note that if your loan required a personal guarantee, it’s possible that your lender will be allowed to seize personal assets to make up the difference of your defaulted loan.
As loans become more delinquent, a lender will become more and more aggressive in collection attempts, which can heavily affect your personal and business credit.
But all hope isn’t lost. Some debtors opt for negotiated debt settlement as a solution to their defaulted loan. However, this is considered a last resort for most people, because the settlement process will prolong your period of financial distress and ruin your credit.
But the good news is that across our economy, small business loan defaults have dropped by four percent since 2009. Before you decide to borrow money, you should be absolutely sure you have a good plan for paying it back. Getting approved for a business loan can be a lengthy process, but it’s worth the time and effort to make sure you and your lender feel confident that you can afford the loan.
The best way to avoid the problems that come along with defaulting on a loan is, of course, to not have to default on a loan in the first place. And if the unexpected happens and you miss a payment, be upfront and honest with your lender as quickly as possible. Your lender will appreciate your proactive thinking and will likely work with you to get your account back in good standing.
Meredith Wood is head of content and editor-in-chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business.