No one enters into a loan agreement with the intention of not paying. Unfortunately, things in life—and business—happen, and you may find yourself unable to meet the agreed-upon repayment terms.
This situation is not uncommon. According to a recent NerdWallet study, 1 out of every 6 SBA 7(a) loans issued between 2006 and 2015 wasn’t paid back, with the average failing loan taking close to five years to reach the default status.
If you have fallen on hard times and now face default on an SBA loan, here’s what you can expect and what you need to know.
What Is an SBA Loan?
Before we dive into the details of the SBA loan default process, let’s quickly define what an SBA loan is.
Contrary to popular belief, the SBA (the Small Business Administration) does not fund small business loans—they guarantee them.
The SBA provides a guarantee to banks and lenders for the money they lend to small business owners. This guarantee protects the lender by promising to pay a portion (up to 85%) of the loan back if the business owner defaults on the loan.
Through this guarantee from the SBA, lenders are taking on less risk when they fund entrepreneurs. As such, SBA loans offer more favorable terms to small business owners, including lower interest rates and lengthier repayment schedules.
To protect their own interests, the SBA defines strict application criteria to qualify for their programs. But even with this filtering process in place, defaults still happen.
When Is My SBA Loan Placed in Default?
The answer to when SBA loan delinquency ends and default begins depends on the individual terms of your contract. In general, lenders will attempt to collect funds up to 90 to 120 days before initiating the SBA loan default process.
Of course, if it is at all possible, try to avoid going into SBA loan default. One of the ways you can do this is by keeping the lines of communication open with your lender. If you’re experiencing financial hardships, letting your lender know may make them more willing to:
- Rework the repayment structure of your contract by lengthening your term
- Allow you to pay only interest for a period of time
- Defer payment altogether for a short period of time
SBA lenders are almost always willing to work with you, so don’t be afraid to reach out to see what options are available.
What Happens When You Default on an SBA Loan: Understanding the Collection Process
If alternative options are not available, or you have no ability to make payments, then SBA loan default becomes a reality. The lender will initiate the collection process, starting with the seizure and liquidation of assets.
Seizure of Business Collateral & Personal Assets
To recoup funds, lenders will attempt to seize and liquidate any assets you listed as collateral on your loan agreement. Such assets include business bank accounts, property, inventory or equipment. You may even be required to sell your business to settle the debt.
To acquire the SBA loan, you likely signed a personal guarantee agreement. If the value of these assets isn’t enough to cover your delinquent debt, your personal assets may be on the line.
What Is a Personal Guarantee Agreement?
A personal guarantee is a formal agreement between yourself and the borrower. It stipulates if your business is unable to repay the debt, you, personally, are responsible. This means the lender has the option to seize and liquidate your personal assets, including real estate and bank accounts. Depending on which state you live in, this could even include the seizure of retirement accounts. The same holds true for any business partner who also signed a guarantee alongside you.
If your business is incorporated or registered as a limited liability company (LLC), you may think you’re in the clear, but this is not the case. A personal guarantee agreement is legally binding even if your business is incorporated or an LLC.
If the debt is still not repaid after the seizure and liquidation of assets, the lender will file a claim with the SBA for the guaranteed portion of the loan, minus the amount they were able to recuperate through the collection process.
At this point, you may be left with no assets (business or personal) but the process isn’t over. With the lender repaid, the federal government will now attempt to recover the funds they gave to the lender.
The SBA Default Collection Process
The SBA will first send you a 60-day demand letter. Within this 60-day period, you will be required to pay the debt in full or provide an offer in compromise.
What Is an Offer in Compromise?
An offer in compromise allows you to settle your debt for less than the full amount you owe. If accepted, the federal government and lender forgive the remaining balance. It’s important to note that an offer in compromise is only applicable to businesses that have ceased operations and liquidated all assets and used those proceeds to reduce their delinquent debt.
SBA Loan Forgiveness Explained
The SBA and lender will accept an offer in compromise if it is deemed fair and sustainable, meaning you have the financial ability to repay the sum within a reasonable time frame.
Your lender and the SBA will make this determination after conducting a thorough review of your finances, including:
- Tax returns
- Assets (business & personal)
- Transfers or acquisitions of assets, including the relationship of and contact information for the person who acquired the asset
- Statement of income
Please note, the SBA does not have to accept your offer. If rejected, you usually have the opportunity to revise your offer and submit it again. For this reason, it may be helpful to seek the advice of an attorney who specializes in debt settlement. He or she may be able to help you craft a sound settlement offer that will have a better chance of being approved by your lender and the SBA.
Transfer to the U.S. Treasury Department
If you can’t reach an agreement with the SBA, your account is transferred to the U.S. Treasury Department and to recoup the funds, the department can leverage a range of collection methods, including the garnishment of any of the following:
- Tax refunds
- Social security benefits
- Federal/military pay
- Federal/military retirements
- Contractor/vendor payments
- Railroad retirement benefits
What to Do if You’re Struggling?
The SBA loan default process is certainly no picnic. It’s stressful, expensive and downright scary at times. Despite this, don’t panic. If you’re facing an SBA loan default, keep the following in mind:
Don’t Avoid Your Lender
When your business is faltering or has failed, it’s no doubt traumatic. But when your lender comes calling, it’s critical that you respond. Otherwise, they might sue you, or close their file and refer it to the SBA. If you ignore the SBA, the file goes to the Treasury, which could mean garnished wages and social security for the rest of your life.
Don’t Hold on to Your Business for Too Long
When you’ve invested so much of your time, money and effort into your business, it can be downright excruciating to let it go. But if it’s clear that failure is inevitable, don’t take on more debt or drain all of your personal reserves to keep your doors open. So before you take another 401K withdrawal to make payroll, think about the fact that if a settlement becomes the goal, you need to have resources to draw from.
Do Consider Hiring a Business-Debt Settlement Attorney
If you find yourself in SBA loan default, don’t wait until the U.S. Treasury Department is garnishing your wages before reaching out to a professional for guidance. A business-debt attorney can help you navigate the collection process, submit an effective offer of compromise claim or determine if declaring bankruptcy is a better choice for your particular situation.
Final Thoughts on Avoiding an SBA Loan Default
When you face the prospect of an SBA loan default, it’s easy to feel powerless and withdrawn. Don’t. Communicate with your lender early and often to arrive at a repayment plan that better suits your financial situation. If circumstances have left you in a position where you simply can’t pay, put in the required effort to settle the debt. Once you are able to turn the page on this unfortunate chapter in your entrepreneurial journey, you can move forward and focus on restoring your financial health.