When you first take out a business loan, you don’t expect anything to go wrong and you fully intend to make all payments on time. Unfortunately, things don’t always work out that way. Your cash flow may get tight for any number of reasons, and, as a result, you may fall behind on a few payments.
Here’s what it means to have a delinquent loan or a loan in default — and here’s what you can do to resolve the problem.
What Is Loan Delinquency?
A loan in delinquent status means that loan payments are past due or in arrears because the borrower hasn’t made the required payments on or before the due dates. Technically, a loan can become delinquent the day after the due date passes.
However, many loans have a grace period usually lasting for a few days after the payment due date. If you make a payment before this grace period ends, you won’t be considered late and may not incur a late payment fee.
A delinquent loan can lead to default if the late payments aren’t brought up to date.
What Are the Consequences of Delinquent Loans?
The consequences of a delinquent loan depend on the type of account, the terms of the contract and the creditor.
Generally, there are 3 things that can happen when a loan becomes delinquent:
1. Late Fees and Penalty Rates
Typically, lenders will charge fees for late payments. Some lenders will charge a late payment fee the day after the due date. Others may give you a few days, maybe up to 14 days, before charging a late fee. In some cases, the lender may start charging a new, higher penalty interest rate, especially credit card issuers.
2. Credit Score
Lenders will report late payments to the credit-rating firms. Notices of late payments are usually sent to consumer credit bureaus after 30 days. Reports to business credit firms are often made sooner, in some cases, just one day after a late payment.
Late payments can affect your personal credit score because payment history represents 35% of your score, according to Experian. Adverse credit information will typically stay on your credit report for up to 7 years. Paying off past due debts won’t get them taken off your credit report, but it will reduce the impact on your score.
Your credit report also will contain information about loans being sent to collection agencies or being charged off, which can have more impact on your credit score than reports of late payments. This information will be available to future possible lenders and could have adverse effects on your ability to get approved for other loans.
3. Collection Efforts
Delinquent borrowers can expect to start getting frequent telephone calls and emails from the lender. Lenders know that it is much easier to collect payments when they’re still only a few days late. The probability of collecting past due payments decreases dramatically over time.
Even if a lender reports to the credit bureaus that a loan has been charged off, that doesn’t mean they will stop trying to collect the balance.
What Is the Difference Between Delinquent and Default?
A loan in default has more serious consequences than a delinquent loan. When a loan has delinquent payments, the lender will step up collection efforts but won’t take any legal actions. If the borrower continues to miss payments, the lender may declare the loan in default. When this happens, the entire balance of the loan, not just the missed payments, becomes due, and the lender will begin to take legal steps to file liens and initiate foreclosure proceedings.
The point when a delinquent loan goes into default depends on the terms of the loan agreement and the lender’s policies. Most creditors will allow a loan to remain delinquent for some period of time before placing it into default.
Before initiating foreclosure actions, the lender will file a public notice of default with the local courts and send a copy to the borrower. This notice will state the number of payments the debtor is behind and how much money is needed to get the payments current. The notice will usually give the debtor a few weeks to come up with the late payments before legal proceedings begin.
The lender’s actions for a loan in default depend on whether the loan is secured or unsecured.
A default on a secured loan could lead to the debtor repossessing the collateral. Business loans are usually secured by the company’s assets, so the borrower could risk losing a piece of equipment, a vehicle or real estate.
If the loan also is secured by a personal guarantee, the borrower could risk losing personal assets, such as bank accounts, automobiles or residences.
Although a loan may be unsecured, the lender still has legal options to collect their money. They can go to court and file a lawsuit against the company. If the debtor fails to respond, the lender could obtain a judgment that will enable them to file a lien against the company’s assets.
It’s much easier to make payments to bring a loan current than it is to remove a loan from default. Removing a loan from default is nearly impossible. Once a notice of default has been filed with the courts, it cannot be removed. Your only option is to negotiate a mutually acceptable settlement.
A notice of default will go on your credit record and will have significant negative effects on your ability to obtain future loans from other lenders.
How to Deal With a Delinquent Loan
Lenders are more willing to deal with delinquencies when the borrower is proactive and takes the initiative to have discussions with the lender to resolve the problem. If you see that you’re going to miss a loan payment, you should immediately contact the lender before you miss the payment and the loan becomes past due.
Your lender might be willing to rework your payment schedule and allow you to make lower payments for a short period of time or extend the terms of your loan. If the situation is especially dire, the lender may be willing to settle the debt for less than the original loan amount.
Show your lender that you’re willing to take positive steps to bring your loan current. Look for ways to cut expenses, even if they are temporary, and present a plan to your lender showing how you can make the reduced payments and will be able to start making full payments in the future.
Lenders don’t want to initiate collection and foreclosure efforts and incur legal fees. Sometimes lenders may be willing to forgive a portion of the debt to avoid the cost of repossessing collateral and selling the assets. Foreclosing on a loan is expensive, and it’s better for all parties to work out a settlement before reaching this point.
Although hindsight is informative, the lesson to be learned from falling behind on your loan payments is to make sure with future loans that your business can handle the payments. Look at your financial projections for the coming years and make sure you have enough cash flow to cover the payments and leave a sufficient cushion for unexpected adverse events.