If you’ve been through the SBA loan application and approval process, you know that getting financing from the U.S. Small Business Administration is a significant accomplishment. After all, even though SBA loans are designed to increase financing options for small businesses, it still requires top qualifications and an extensive application process to receive this type of funding. But, despite your best efforts, you might find yourself in financial trouble—so much so that you’re worried about facing an SBA loan default.
Unfortunately, if you think you might default on your loan, you’re not the first, and won’t be the last business, in this situation. In this guide, we’ll explain everything you need to know about the SBA loan default process—including how to determine whether or not your loan is in default, what happens if you do default on your loan, and tips to avoid loan default in the future.
First, it’s important to understand exactly what SBA loan default is. Although the SBA guarantees a portion of their loans, you most likely obtained your loan from an SBA lending partner, like a bank, and therefore, some of the policies and processes around loan default will vary based on your lender.
Nevertheless, to get a better sense of what SBA loan default means, you need to understand the difference between delinquency and default.
Delinquency and loan default have very different consequences—which is why it’s so important to understand where SBA loan delinquency ends and default begins.
Generally, if you’re delinquent on your SBA loan payments, that means that you’re behind, but your lender hasn’t marked you as entirely unable to pay. When you’re delinquent, you can expect that your lender will assess a late fee (though it will vary depending on whom you’re working with). This being said, as we mentioned, although each bank or intermediary lender has a different policy about how they contact delinquent borrowers, you can expect them to reach out to you to figure out why you’re late.
At this point, the good news is that by contacting you about your late payments, your lender will likely try to work with you in your situation to get repayment—possibly by restructuring your terms or figuring out another solution. Overall, you’ll usually have about 30 days to pay your lender some balance, or come to an arrangement before your delinquency gets reported to the credit bureaus and you’re flagged as a possible default.
Therefore, compared to delinquency, SBA loan default (or any type of loan default, for that matter) means that you’ve missed payments for a long period of time—generally because you don’t have the funds to pay back what you owe. In this case, lenders typically wait about 90 to 120 days before initiating the default process. The exact timing, however, before a lender will declare your loan in default will often be specified in the terms of your contract (as seen in the example below).
Although typically SBA loan default refers to your inability to pay back your loan, after having missed payments continuously over a period of time, there is also another type of default, called accidental default.
You could face accidental default if you violate a clause in your SBA loan agreement, even if you have perfect credit and make all of your payments on time. Unfortunately, by violating “the fine print,” you could automatically send your SBA loan (again, or any other loan) into default.
As an example, if you stack another loan on top of your existing SBA loan or add new shareholders to your company without informing the SBA, you would violate your loan agreement, thereby sending your SBA loan into accidental default.
Luckily, if you’ve realized that you have not yet reached the point of SBA loan default, there are a few strategies you can employ to avoid it altogether. If you’re currently having trouble making payments and you’re in SBA loan delinquency, or you simply anticipate being unable to pay your loan, there are a few actions you can take:
If your business financials aren’t performing the way you anticipated they would when you first took out your SBA loan, it’s only natural that you’re going to have a harder time coming up with the money to make your loan payments. Therefore, before you send your SBA loan into default, you might want to evaluate your finances and see if there are places you can cut costs and any possible ways you can save money to be put to your loan payments.
You’ll specifically want to take a look at your cash flow forecasts—as these projections will give you the best sense of whether you’ll have the liquidity to pay your lender within the near future.
In general, since your cash flow is one of the best indicators of your business’s financial health, you should always be monitoring your cash flow carefully. Along these lines, if you don’t have positive cash flow—or if your projections say you’re not going to be able to make up the ground you’ve lost when you’re behind on loan payments—you should be more concerned about the possibility of SBA loan default.
Another thing you can do if you think you’re in trouble with your loan payments and want to avoid default is to proactively contact your lender. Although you may feel awkward about admitting that you’re having issues with your payments, it’s very likely that your lender would like to work something out with you—instead of having to track you down when you’ve missed multiple payments.
Overall, as a general rule of thumb for all business loans, you should try to talk to your lender about problems with payments as opposed to letting your loan fall into default. After all, a lender never actually wants you to be in a position where you can’t pay them back—as they’re in the business of getting back their money—so they’d rather you give them the heads up that your circumstances have changed.
In most cases, lenders will be willing to work with you, if possible, to change your repayment structure. Your lender may be able to set up a plan where you only pay the interest on your loan for the time being—or at least give you a bit more time to make your payments.
Of course, any agreement you make will have to be approved by the SBA, but again, the government would rather have you work something out instead of forcing you into SBA loan default.
Even if you try your best to avoid SBA loan default, sometimes it happens. As we mentioned above, some of what happens next will depend on your lender, as well as the type of SBA loan you have.
As an example, if you experience an SBA disaster loan default, you’ll actually have to work with the SBA through this process—as disaster loans are one of the only programs where funds are issued directly from the SBA. On the other hand, for most other programs, you’ll be working with your lender through the default process.
Unfortunately, if you have an SBA 504 loan default, you’ll have a more complicated process, due to the multiple lenders involved with that loan type.
All of this being said, however, here’s what you can generally expect to happen if you default on an SBA loan:
As we’ve discussed, if you aren’t able to work with your lender or find the capital to make up some of your payments, then your SBA loan will fall into default. At this point, you’ll likely receive what’s called a demand letter—which is a legal notice that means that you’re on the bank’s radar for default. You definitely do not want to ignore this notice.
After this notice has been sent, your lender will attempt to seize and liquidate any assets you listed as collateral on your SBA loan. This collateral might include business bank accounts, real estate, machinery, inventory, or equipment—anything that you used to guarantee the debt. Unfortunately, if your business needs to “cease operations”—the SBA’s term to foreclose—to settle debts, you’ll need to do that in lieu of settling your loan.
If your lender isn’t able to recoup enough through your business assets, or through the sale of your business (or if you no longer own the items you used as collateral, which is a certainly something you don’t want to do), they may come after your personal property.
The SBA loan personal guarantee that signed when you received the loan gives your lender the right to seize your personal property in the event your business can’t pay with its own assets. In this way, any business partner, investor, or stakeholder who signed a personal guarantee for the loan is also subject to the same possibility.
All of this being said, although the SBA guaranteed a portion of your loan to the intermediary lender—they’ll be the last entity that your lender is going to approach to get their money back—meaning they’ll explore every avenue to get the money from you, your business, and any other guarantors on the loan.
Even though your lender will approach the SBA last, the SBA will definitely get involved in the default process.
Due to the SBA guarantee on the loan, anywhere as high as 85% of the loan amount, your lender doesn’t have to recoup the full loan amount from you to earn their money back. Therefore, if you pay up to what your lender needs to recover, you would think you wouldn’t necessarily need to be concerned with the remaining percentage.
This being said, however, since the government is now in the place to lose money on this loan, they’ll want to try to get as much of that remaining balance back from you as possible. The SBA will begin its debt collection process with a 60-day demand letter.
This letter indicates that the U.S. Treasury Department is in charge of getting the government’s money back. Additionally, the demand letter is their way of letting you know that you have 60 days to get the money together before they begin going through your finances.
At this point, there’s no real way to avoid paying something back if you’ve managed to escape it previously. The Treasury knows what money you have, what money you make, and how much you can devote to paying off your defaulted SBA loan.
Although this may sound overwhelming, the government will likely be willing to work with you to recoup their loses. In many cases, you’ll be able to offer a lump sum payment, which is more common—or work out a repayment plan in some other situations.
If you don’t have any more money to pay at all, you’ll complete a form known as the Offer in Compromise (shown below). This form is essentially your last chance to show the SBA (and your SBA lender if you haven’t paid them much, either) that you simply can’t pay—no matter how much you wish you could.
All in all, the offer in compromise form asks you to detail your finances, including tax returns, personal and business assets, transfers of assets to other people (along with their personal information), income statements, and expenses. You’ll need to show the SBA without a shadow of a doubt that your business has closed (as in, has been liquidated and is no longer in existence), and your personal finances are empty.
Unfortunately, the SBA doesn’t have to accept your offer in compromise—in fact, they can reject it. On the other hand, however, if both the lender and the SBA accept your offer in compromise, you’ll come to terms on a settlement and a date to pay it.
Hopefully, with the SBA loan default options we’ve discussed thus far, you won’t end up in a problematic legal situation. In certain cases, however, an SBA loan default can result in litigation, but there are ways to avoid this outcome.
First and foremost, you want to acknowledge your default. If you can’t pay, you need to be in touch with your lender and the SBA. Along these lines, you don’t want to ignore communications, like demand letters. You should remember that although defaulting on your SBA loan may be overwhelming, the federal government and your business lender have likely gone through this process before.
This, as you might imagine, means they have a very specific process—which includes documentation and recordkeeping—in case they do have to initiate legal action. In this way, the lender and the SBA are much more equipped and prepared to handle litigation.
As an example, if you do ignore communication about your loan default, the SBA has the legal right to refer your loan to the Treasury and begin collecting on assets they know you have, like bank accounts and collateral. Additionally, they also have the ability to begin to garnish wages in order to collect on their debt.
Therefore, although you might feel tempted to ignore communications about your debt, the best thing you can do is engage in correspondence. If you don’t actively work through the situation, you’ll incur additional penalties from both your lender and the government, potentially become involved in a lawsuit, and lose the opportunity to negotiate a payment plan that might work for you.
At the end of the day, there’s no doubt that the SBA loan default process is lengthy and discouraging. When your business is in financial trouble, it’s never an easy situation to deal with.
This being said, however, the best thing you can do is to be proactive. Before you face actual default or the threat of legal action, contact your lender and work with them as you can. As we’ve discussed, it’s very likely that your lender will try to work something out—instead of forcing you both through the difficult default process.
Plus, it’s always important to remember that in times of trouble, it’s helpful to consult business experts. If you think you might face an SBA loan default, you might decide to ask a business attorney, accountant, or other professional for assistance.
Meredith Wood is the founding editor of the Fundera Ledger and a vice president at Fundera.
Meredith launched the Fundera Ledger in 2014. She has specialized in financial advice for small business owners for almost a decade. Meredith is frequently sought out for her expertise in small business lending and financial management.