What Happens If You Default on an SBA Loan?

Defaulting on SBA Loan

Part of the process of starting a new business or buying into a franchise is figuring out your financing options. When it comes to franchise ownership, it is common for potential franchisees to get their business loan from the U.S. Small Business Administration (SBA). While it is known as an SBA loan, it is actually a process in which the federal government provides a guarantee to a private lender. This makes it easier for the borrower to obtain a loan. Pre-COVID-19, SBA loans were more difficult to acquire due to the requirements and documents needed. However, in an effort to get small businesses funded more quickly during the pandemic, the SBA simplified the application process making SBA loans even easier to obtain.    

Even though COVID-19 negatively impacted the economy, SBA loan recipients are still responsible for making their payments on time. If they are unable to do so, they run the risk of defaulting on their loan, which could have serious consequences. 

Difference Between “Delinquent” & “Default”

When it comes to paying back a loan, being delinquent and defaulting on the loan are two different things. 

Being delinquent on a loan means that you haven’t kept up on your payments, but the lender is still willing to work with you to get the loan paid in part or in full. 

Defaulting on a loan means that the lender does not expect you to pay back the loan and consequently pursues appropriate legal action. 

Who Decides If You Have Defaulted on Your SBA Loan?  

In most cases, the SBA backs a loan through a bank or other financial institution in order to reduce the lender’s risk and increase opportunities for small business owners. As a result, the private lender will likely decide if your status is delinquent or if you have defaulted on your loan. 

What to Expect When You Fall Behind on Payments  

If you fall behind on your SBA loan repayments, then you can expect that your lender will contact you to arrange a payment with a late fee included. You should have the chance to explain your situation, and if the lender agrees, you can come up with a solution such as restructuring the terms of the agreement. After all, it is in the lender’s best interest to find a way for you to repay what you owe. If the lender is flexible, you might have a few options: 

  • Increasing the amount of time you have to repay the loan, which would translate into smaller monthly payments 
  • Getting advice on how you run your business in case there is a way to find more money for your loan payments 
  • Only having to pay the loan’s interest for a period of time while you assess your business’s finances 

It is a serious matter to fall behind on your SBA loan payments, and it’s important to do everything you can to set things right. While your lender wants to find a way to get paid, if you are unable to make loan payments within a reasonable timeframe then you will begin to experience the consequences, which include: 

  • Initially, you will receive “late” marks on your credit reports (both business and personal). 
  • If you continue to not make a loan payment, then you will receive derogatory marks, which are “negative, long-lasting indications on your credit reports” (Credit Karma).
  • Finally, if you still haven’t started making payments for a certain period of time (usually between 90-120 days), then your loan will go into default

4 Steps to Take When You Are Delinquent on an SBA Loan  

  1. Communicate – It is essential that you contact your lender as soon as you know you won’t be able to keep up with your payments. In order to work out a possible solution with them, you need to be open and transparent. 
  2. Restructure the repayment plan – As mentioned already, there are different ways to adjust how the loan gets repaid. 
  3. Review your finances – Re-evaluating your cash flow and expenses might free up the money you need to get back on track with your loan payments.
  4. Seek help – If you are on the path to defaulting on your SBA loan, it is important to talk to a professional who can help you understand your options, such as an accountant or business attorney.  

What Are the Consequences for Defaulting on Your SBA Loan?

Defaulting on a loan of any kind can lead to serious consequences. These include: 

  • Credit score will take a hit – A defaulted loan will appear on your personal and business credit reports and will certainly impact your credit score. These marks on your credit score could also hurt your chances at getting another loan in the future. 
  • Legal action will be taken – The SBA will demand repayment of the loan, and if you don’t respond, then either the SBA or the lender will start going through your business and personal finances looking for money that will satisfy the loan. This means that you will risk losing the collateral that you or anyone else offered to initially secure the loan. 

What Should You Do If You Have Defaulted on Your SBA Loan?  

There are a few actions you should take if you have defaulted on your SBA loan: 

  1. Pay something – Even if it’s not the full payment, offer some amount of money as a gesture of goodwill.
  2. Legally prepare – You can expect legal action as the lender and SBA seek payment via your business or personal funds. 
  3. Offer in Compromise (OIC) – When you submit an “offer in compromise”, you offer to repay a portion of the SBA loan in order to settle the debt completely. The amount that you repay is determined after a thorough evaluation of your finances. 

Don’t Default on Your SBA Loan

Obviously, business owners don’t plan to default on their loans when they first obtain them, but it happens nonetheless. However, you can avoid this scenario if you stay on top of your cash flow and prioritize your SBA loan repayments from the start. 

Additionally, choosing the right franchise and writing a thorough business plan are key to your success as a franchise business owner. The good news is that FranNet can help! At no cost to you, one of our franchise consultants will help you browse hundreds of franchise brands in your local market and focus on connecting you to the right opportunity. We also will help you understand your financing options and provide you with resources and support every step of the way. Work with a FranNet franchise consultant and set yourself up for success as a franchise business owner. Schedule your free consultation today! 

Mar 29, 2023