What Happens To Small Business Loan If Business Fails?

Being your own boss has been the most lucrative working option from the past to the present, especially due to the Covid-19 pandemic and will possibly continue to be in the future. Freedom is the key point of interest here. But is that really true? According to “successful” people, yes. Self-employment or owning a business gives one an incomparable amount of freedom and flexibility. The point to note here is “successful”. One of the worst mistake people make is trying to replicate success without researching all aspects. Starting a small business without prior experience or research, in most cases, is doomed to crash. Thus, it is very important to research and keep researching prior to and throughout the life of a business.

Due to its importance in the development of society, even federal governments try to promote small businesses. In the US, SBA(Small Business Administration) is a federal agency solely created to aid small businesses in acquiring necessary funds.

Do prior research, take an SBA loan, start a business, see the profits coming in and finally be loan free after some time. That is the most ideal situation which quite a handful of businesses fail to convert into reality. The business may face hardship. Sales may plummet. Bad debt may arise. And hopefully, never again, a pandemic can obliterate each and every plan you ever created.

An SBA loan default usually means doom for one’s business and unfortunately, it isn’t that uncommon. To be said nothing for the data from the Covid-19 pandemic period, even in the data from 2006-15 a steady undesirable 1 in 6 default in SBA 7(a) loans is easily noticeable. Therefore, one must know the ways to salvage the situation in case it goes south.

Different types of loans; What happens when one defaults on a loan;

The process of repayment on loan differs with the type of loan taken:

  1. Unsecured Loans

These types of loans don’t require any collateral from the borrower. Due to being risky in nature, these loans are not very popular among lenders. These loans tend to be smaller in value, have higher interest rates and have shorter repayment terms. In case of a default, the lender can come after the personal assets of the borrower.

  1. Secured Loans

These are a more popular type of loan where collateral of equal or exceeding the value of the loan is specified at the time of agreement. In case of a default, the promised collateral becomes the property of the lender.

  1. Secured SBA Loans

Created especially for small businesses, this federal-backed loan is the most recommended type of loan for small businesses. Due to the guarantee of up to 85% of the loan by the federal government, lenders tend to favour this mode. On default, the lenders first try to collect the loan as per the agreement. The remaining loan amount is then transferred to the SBA. At this point, the SBA provides the option of making an offer in compromise to the borrower. In case, resolution can’t be made, the account is further submitted to Treasury Department.

What happens when an SBA loan is in trouble

Since SBA is only a guarantor and not a lender, the borrower of an SBA loan first needs to discuss with the lender. Commercial lenders typically try to settle a troubled loan peacefully but every lender usually has some different policies for the process.

Normally, the lenders would alert the borrowers after a 10-day grace period. Some of the common ways to deal with a loan default include loan restructuring, change in payment time, interest-only payments etc. The advantage here, the loan will not be counted as default.

What borrowers should do in case the SBA loan is in trouble

Communication is the best way to prove your sincerity to your lenders. Notifying lenders beforehand helps the borrower to understand the situation faster and formulate better ways of settlement. It also gives a good impression and saves a few headaches on the part of the borrower.

Default on a loan can be very detrimental in the future for an individual. Therefore, discussing and formulating a way out with the borrower before the case is unsalvageable is the best option.

How does the lender collect in case of an unavoidable default?

Although the federal government guarantees— 85% if the loan amount is less than $150,000 and 75% in case the loan amount is greater than $150,000— this guarantee is called only if no other resolution can be found.

In case of default, the lender has a right to collect the collateral initially agreed upon. If the collateral isn’t able to satisfy the outstanding loan amount, the lender has the right to also collect on the personal guarantees made by the borrower.

In cases where the loan amount is still not satisfied, the lender can then submit the losses to the SBA to honour its guarantee. In such cases, the federal government can take additional measures like freezing borrowers’ bank accounts to recover the amount.

Thus, it is advised to not let an SBA loan escalate till this case. Neither the borrower nor the lender usually wants the loan to reach here since both parties suffer losses. Therefore, communicating and finding out an early resolution is the best way to go around and most lenders would be more than willing to help the borrower by providing the option to restructure the loan or change some terms.

FAQs

Q1. Why is a default on loan so greatly advised against?

Ans. Default on loan is detrimental to both parties, borrower and lender, but the loss on the side of the borrower is more. After a default, the personal credit score and the ability to take loans in future of the borrower is seriously affected. Other negative effects include, but are not limited to, the lender trying to recover the loan by collecting collateral and other personal guarantees, action by Treasury Department to recover the amount.

Q2. Does SBA pay on your behalf in case of a default?

Ans. Yes. In case of an unsalvageable default, the lender first tries to recover the loan amount according to the terms in the loan agreement. If the amount recovered isn’t satisfactory, they can submit a claim to SBA. The SBA, in this case, would pay on your behalf but seek compensation for this amount.

Q3. What happens if negotiations with SBA on default on a loan fails?

Ans. In case the SBA turns down the offer in compromise and an acceptable resolution can’t be done, the account is sent to the Treasury Department. The Treasury Department can forcibly collect money by various means like freezing bank accounts, taking away tax returns or garnishing wages.

Q4. Why did my SBA loan go into default even when I did repayments on time?

Ans. One may face an accidental SBA loan default even with timely repayments. The most common reason for this include overlooking the terms stated in the SBA loan agreement. Eg. Stacking a loan on top of an SBA loan without informing SBA can lead to this.

Q5. What does a delinquent borrower mean?

Ans. A borrower is marked as delinquent when they are behind on their loan payments but not completely marked as defaulters. The lenders usually impose a late fee in such a case.

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