However, if, during the course of business, an SBA loan recipient becomes unable to pay its loan, the lender will make attempts to collect any pledged collateral. The lender will then turn the debt over to the SBA. The government has standards and practices to recoup lost funds, but it may be able to settle with the loan holder for a reduced amount. This process can be costly and time consuming for the business owner but can ultimately result in a form of loan forgiveness. We’ll discuss what happens when you default on a loan and how loan forgiveness works.
How Do SBA Loans Work?
SBA loans are an ideal resource for small businesses that might not otherwise qualify for traditional loans. The SBA offers various loan products ranging from $500 to $5.5 million in funding, all with competitive rates, broad eligibility requirements, and reasonable terms. The federal government partners with third-party lenders, such as commercial banks or local credit unions. These lenders vet applicants, own the loan, and collect the interest. The SBA sets the terms, conditions, and eligibility of each type of loan, and lenders must uphold those guidelines when evaluating applicants. Ultimately, these loans can be far less risky for the third-party lenders because the SBA guarantees a portion of the funds, usually somewhere between 50% and 85%.
What Happens When You Default on an SBA Loan?
There may come a time when a small business is unable to repay a loan issued by the SBA via a third-party lender. Perhaps you need to delay payment due to a cash flow issue, or maybe you’ve exhausted your resources and can no longer meet the payment terms. Regardless, once your business starts to miss its scheduled loan payments, you’ll become delinquent on your debt.
The Default Process
Some lenders will work with businesses for a few months to avoid sending a loan into default. But if a business continues to skip payments without an arrangement with the lender, then the latter usually has no choice but to send the loan into default. Defaulting on a loan is likely to have a very negative effect on your business’s credit, and often on your personal credit, as well. Here is an outline of what happens if you default on an SBA loan:
How SBA Loan Forgiveness Works
Once a business has no more options for debt repayment, it may have to cease operations. At this point, any remaining collateral will be liquidated to pay back the SBA loan. When it’s clear that there are no remaining assets to support loan repayment, the SBA will likely issue an “offer in compromise” to borrowers who cannot fully repay their loan. An offer in compromise arrives via a form from the government and the business owner must propose a settlement amount within 60 days. To have an offer in compromise approved, the business will also have to use financial statements to prove that the loan is in liquidation and that the business cannot support the loan payments. Generally, this is done through business and personal tax returns, financial statements, and any corroborating evidence regarding business and personal assets. While the SBA will not forgive 100% of the debt owed, the goal is to settle on a number that makes sense for both the agency’s bottom line and a business’s financial ability to pay. If the SBA approves the offer in compromise, a payment will be issued and the loan will be classified as “Compromised/Closed.”
How To Increase Your Chances of Loan Forgiveness
Small businesses commonly run into cash flow roadblocks that may make repaying a loan difficult. This is partially why the SBA loan program exists in the first place—to give otherwise relatively volatile loan candidates a fair shake at the necessary capital to grow and succeed. If a business simply can’t make its payments, however, the first thing its owner should do is be proactive with their lender. Some banks and credit unions may be able to renegotiate loan terms, interest payments, or payment plans to ensure that you can avoid going into default.
