What Happens if You Default on a Business Loan?

What Does It Mean to Default on a Business Loan?

Defaulting on a small business loan occurs when you've repeatedly violated the terms of your loan agreement. This could mean missing multiple payments (or making partial payments): Business loans typically go into default after three to six missed payments. Default may also involve failing to comply with financial covenants that are part of your loan terms, such as minimum revenue requirements.

In essence, a default means the lender has decided you can't or won't repay the loan according to your original terms. When your loan goes into default, the lender will try to collect your remaining loan balance and will report late payments, collections and the default to business credit reporting agencies (Experian Business, Dun & Bradstreet, Equifax Business), as well as consumer credit bureaus if your personal credit was used to obtain the loan.

Business Loan Default vs. Delinquency

Delinquency can happen as soon as your first payment is late. Where default generally involves multiple late payments or violations of your loan terms, delinquency may involve only one. In most cases, you can get out of delinquency by making your payment and bringing your account current, though you may still pay late fees and have your late payment reported to credit bureaus.

What Happens if You Default on a Business Loan?

Defaulting on a business loan can have serious consequences to your business and personal finances and credit. You can expect your lender to take serious action to collect your debt, including charging fees and penalties, seizing assets and reporting problems to business (and possibly personal) credit reporting agencies. Here's a quick rundown of common consequences.

You May Owe Late Fees and Penalty Interest

Late fees begin when you miss your first payment. Although many loan agreements allow a grace period of a few days to a few weeks before payments officially become delinquent, once you've passed the grace period, fees and penalties begin to accrue. Late payments may also trigger penalty interest rates, which will increase your loan costs going forward.

Your Debt May Be Sent to Collections

When your loan goes into default, collection efforts will intensify. Your lender may use their own internal collections department or sell your debt to an outside collection agency. The federal law that protects consumers against hardline collections doesn't apply to business collections, so you can expect collection agents to be persistent about contacting you. Collections may also involve court judgments and lawsuits.

Your Lender May Demand Full Repayment

If your loan agreement includes an acceleration clause, your lender may have the right to demand the full repayment of your loan balance. Instead of paying off your loan over the remainder of your loan term, your entire balance is due immediately. Though this shift is understandably jarring, it marks an important step. Your lender is no longer trying to collect monthly payments; they're recalling the entire loan.

Your Lender May Seize Collateral

If you secured your business loan with collateral, your lender may seize it and liquidate it to recoup the debt. Depending on the asset, the loss may be more than financial. For example, if your lender takes possession of equipment you pledged to secure an equipment loan, you may not be able to continue operating your business.

Even if your original loan agreement did not include collateral, your lender may attempt to seize assets like your bank account through legal action.

Tip: Consider contacting a bankruptcy attorney who can help you understand your rights, negotiate terms with your lender and represent you in court, if necessary.

You May Lose Personal Assets

Many business borrowers back unsecured business loans with personal guarantees. If you did this, your personal assets may also be in play. Your home or home equity, investments, savings and other personal assets may be at risk. The same may be true for all signatories on your loan, including cosigners.

Your Business Credit Will Be Damaged

Business loans appear on your business credit report and factor into your business credit score. The three primary business credit reporting agencies receive information from lenders and credit card companies, public records, state filing offices, collection agencies and other sources. Business credit scoring models use this information to generate a business credit score that lenders and vendors may use to evaluate your business's creditworthiness.

Although your business credit report and score are different from your personal credit report and score—with information maintained in separate databases—some similarities apply. For example, your payment history factors significantly into your business credit score, just as it does with your personal credit. Collections, bankruptcies and judgments may also appear in your business credit report and affect your business credit score.

Learn more: How to Build Business Credit

Does Defaulting on a Business Loan Affect Your Personal Credit?

In some cases, a business loan default can also affect your personal credit. Here are three factors that help determine whether and how your business loan may impact your personal credit:

• How your business is structured: If you are a sole proprietor, your personal credit will almost certainly be affected by a business loan default.
• How your loan is structured: Even if you aren't a sole proprietor, your personal credit may be implicated if you used it to apply for your business loan. Personal guarantees are common for startup loans to businesses that don't have much of a credit history and for Small Business Administration (SBA) loans. If you're not sure whether your personal credit was involved in guaranteeing your loan, check your loan documents.
• How your default is resolved: If your loan default eventually leads to business bankruptcy and your personal assets are at risk, you may consider personal bankruptcy as well. Filing personal bankruptcy will, of course, have a major impact on your personal credit. You may benefit from consulting with an experienced bankruptcy attorney if you find yourself in this predicament.

How to Avoid Defaulting on a Business Loan

Given the many negative consequences of loan default, it's worth doing everything you can to avoid it. Here are some steps to consider if you're concerned about making your loan payments.

• Monitor your finances. Review your cash flow statements frequently so you can anticipate issues and look for solutions before you have missed payments or a default. You may be able to cut costs or liquidate nonessential assets to bring your finances back into line. If your financial statements point to serious long-term problems, it's better to clock them early: You may have more options—and more time to decide between them—if you're on top of your finances.
• Build up emergency reserves. Try to keep several months' expenses on hand to use in a cash-flow emergency. Only tap your emergency fund when absolutely necessary, so your funds won't be depleted when you need them.
• Talk to your lender early: Reach out to your lender as soon as possible, preferably before you miss a payment. Because collections and legal actions are costly for lenders, many will work with you to avoid default, possibly by restructuring your loan, offering loan forbearance or accepting interest-only payments for a period of time.
• Get professional help. Working with a business financial advisor, accountant, nonprofit credit counselor, debt settlement attorney or bankruptcy attorney may help you navigate forward with as little damage as possible to your business and credit. Getting through this process can be difficult. Having the benefit of expert advice can't be overestimated.
• Consider new financing options. You may be able to lower your monthly payments by refinancing your debt at a lower interest rate—or for a longer term. If you have multiple debt payments to manage, debt consolidation might help you streamline. Alternative financing, including short-term options like invoice factoring, might help you get through a rough spot without defaulting on your loan.
• Mind your credit. Late payments, collections, default and bankruptcy all have a negative effect on your credit. In some cases, these effects can land on both your business and personal credit when you default on a business loan. Yet, preserving your good credit is important—not only as a general matter, but also to maximize your options for financing debt and running your business as you move forward.

Check your business credit report and score regularly to see how repayment issues may be affecting your credit. You can check your business credit at any of the three major business credit bureaus for a fee. You also can check your personal credit reports at all three consumer credit reporting agencies (Experian, TransUnion and Equifax) at AnnualCreditReport.com.

Frequently Asked Questions

The Bottom Line

If you're having trouble keeping up with business loan payments, take stock of your situation and contact your lender as soon as possible. Default typically happens when you're three to six months behind in your loan payments, but it can occur much more quickly depending on your lender and loan terms. By reaching out early, you may be able to work out a mutually agreeable resolution and minimize damage to your business, personal assets and credit.

In addition to checking your business credit report and score regularly, consider free credit monitoring with Experian. You'll be alerted whenever there are changes to your personal credit file and get suggestions on improving your personal credit score as you navigate challenges with your business finances.