Nobody plans to default on a loan.
When you decide to start a small business, it’s no surprise that the excitement of what the future holds outweighs the fear of failure. If you aren’t confident about your investment, who will be? Nonetheless, some businesses are destined to succeed and some are not.
According to the Small Business Administration, only two-thirds of small businesses survive more than two years, while less than half make it to five. These statistics remain consistent over time, suggesting that economic factors are of little impact. So if you are struggling to pay off your business debt, you are not alone.
What does it mean to default on a business loan?
Defaulting means you were unable to meet the terms of your loan contract, whatever those may be. Some loans default after one or two missed payments, while others don’t default unless you are unable to pay off the entire loan on time.
There is some variation when it comes to small partnership debts—as well as secured and unsecured loans. Yet, most business loans result in the same personal and financial repercussions as any loan contract, including:
- A drop in credit score
- An increase in interest rates
- Repossession of personal and financial assets
- Difficulty in securing future loans
What is the difference between a secured and an unsecured loan?
A secured loan is backed by an asset, such as a house or a car. If you default on the loan, the property is sold to cover the debt. If it cannot cover the loan in full, it is possible for the lender to demand you pay the difference.
An unsecured loan is not tied to any asset, which means the lender cannot immediately reclaim your property. While this sounds ideal, it requires a pretty amazing credit history and a solid income. Even then, it’s possible for the lender of an unsecured loan to litigate against your company to collect.
So what really happens when you default on a business loan?
Regardless of the exact terms of your loan contract, or whether it is secured or unsecured, if you default on a business loan you may face one more of the following repercussions:
Drop in credit score
The first financial consequence of defaulting on a business loan is a drop in your credit score. Your credit score will drop after a single missed payment and will continue to drop as your bills pile up.
To avoid certain personal liabilities, it is possible to avoid listing your name on the loan contract . If this is the case, only your business credit will be affected. However, if your name appears on the contract, your personal credit will be impacted as well.
Increase in interest rate
When credit scores drop, interest rates increase. This is certainly true of future credit, but it can also affect current adjustable business loans and lines of credit. As opposed to a fixed rate, an adjustable rate is susceptible to fluctuations in market value, which means it can and will increase if you default on a loan. Credit cards are a form of adjustable rate financing.
If you are already worried about what happens when you default on a business loan, there is a good chance you will be negatively affected by having to pay additional interest on the rest of the debt you currently possess.
Repossession of personal and financial assets
If you secured your loan with collateral, your creditor could seize it as soon as you default. In the case of a business property, this can result in foreclosure. While it should be considered a last resort, it is possible to file a Chapter 11 bankruptcy to temporarily halt the foreclosure until your debt reorganization plan is approved by a court.
Even in the case of unsecured loans, it is possible for the lender to litigate against the business to garnish your bank accounts or place a lien on any real estate or vehicles owned by the business. Regardless of the terms of your contract, you may require legal assistance to avoid losing your personal assets.
Difficulty in securing future loans
An obvious consequence of defaulting on a business loan is difficulty in getting a new one. It will come with an unusually high interest rate and probably require a decent amount of personal collateral. Depending on the type of loan, and how much your personal credit is affected, this will also be the case for credit cards, auto loans, mortgages, and more.
It is always in your best interest to avoid filing for bankruptcy, but if your personal property is at risk, it may still be your best bet. A bankruptcy will remain on your credit for many years, but you can use that time to rebuild your credit to a point even higher than where it began.
If you need help figuring out how to avoid defaulting on your business loan, contact the legal experts at Affordable Debt Solutions or get started now with 13 Questions to Ask Debt Consolidation Companies.