By Stephanie Raimbert
U.S. states hit hardest by COVID-19 had some of the biggest jumps in small business loan defaults since the onset of the pandemic and some of the highest rates of default overall, according to data provided to Reuters by PayNet, a division of credit tracking company Equifax Inc. From before the pandemic in February 2020 to the most recent data available in June, defaults among small businesses rose fastest in New York, where the disease has killed more people than in any other state. The state with the highest per-capita case count as of the end of July, Louisiana had the fourth-highest default rate among small businesses in the U.S. Florida, with the fourth highest per-capita COVID-19 case count, had the highest default rate of any state, at 4.29%.
Since small businesses depend on borrowing money to grow, this can increase the possibility of falling into financial hardship and defaulting on their loans. Especially during the coronavirus pandemic, small businesses going through a tough time might find it difficult to pay back loan payments. This puts you at risk of a loan default, which can affect your credit history and have other major consequences for you and your business, so it is critical to handle this situation correctly. Although the specifics of the default procedure will vary depending on your state, lender, type of loan, and loan agreement, here are some general guidelines about what to expect in the event of a loan default and how to avoid a loan default in the first place.
How to avoid defaulting on any business loan?
Since loan default can affect your credit score and finances, which can limit future financing, it is best to try to prevent defaulting on any business loan. Fundera recommends taking proactive measures outlined below to avoid loan default:
Contact the lender right away – If you are struggling to make your loan payments, you should contact the lender right away. The lender might be able to extend your loan term, defer some payments or arrange a payment plan with you. If you keep an open line of communication, the lender will more likely be understanding and avoid collection efforts. Be ready to answer questions about your business and personal income and be sure to document the terms of any payment plan in writing.
Pay what you can – Even if you cannot afford the entire payment, making smaller micropayments will help you avoid a full-blown default. The lender, seeing that you are making a good faith effort to pay back the loan, might be more amenable to a payment plan for your loan.
Consider seeing a debt counselor – If you are really struggling under a heavy burden of debt, you might want to consider making an appointment with a debt counselor or credit counselor. They can give you debt management strategies for paying down debt.
See a bankruptcy lawyer – Sometimes when a business owner defaults on a loan, bankruptcy is not far off. Bankruptcy can have even bigger repercussions than a default on your credit and finances. If you are considering filing for bankruptcy, contact an experienced bankruptcy attorney to walk through your options.
When a loan falls into default, the status will show up on your credit report within 30 days. If you pay off the account after that, the negative marks will not automatically disappear from your credit report. Defaults can stay on your credit report for up to seven years. Fortunately, their effect decreases over time, and the lender might remove them sooner as a sign of good will.
What happens when you default on an SBA loan?
Defaulting on a Small Business Association (SBA) loan entails a different process than defaulting on a standard bank loan. Because an SBA loan is a federal loan, there are special procedures and methods in place that the government can use to collect on the unpaid debt. Business.com states that the SBA itself is not a lender; it only guarantees up to 85% of the loan amount to lenders who give SBA loans. If you default on an SBA loan, you will deal directly with your lender, not the SBA. The lender will call in the SBA guarantee only when its efforts to collect payment from you fails, and that is when SBA gets involved. Essentially, dealing with the SBA after an SBA loan default is kind of like dealing with the IRS when you have not paid your taxes, according to Fundera.
If you are not 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 will likely receive a demand letter, which is a legal notice to tell you that you are on the bank’s radar for default. 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 will need to do that in lieu of settling your loan.
When does the SBA get involved in the default?
Ultimately, if your bank lender has exhausted all ways for recovering the debt but still has not recovered the full amount of the loan, the lender will make a claim to the Small Business Administration. At this point, the SBA will pay out the guarantee fee (discussed below) to your bank and take over the collections process. The SBA will then send you a letter requesting that you either pay the full amount due or present an “offer in compromise” within 60 days. If you do not respond to this letter, your debt will be sent to the U.S. Treasury Department for collections.
What are SBA Guarantee Fees?
According to Value Penguin, SBA will back a portion of the loan that the bank makes to you, guaranteeing up to 75% to 85% of all 7(a) loans. The SBA guarantees up to 85% of loans of $150,000 or less and up to 75% of loans over $150,000. Only 7(a) loans are subject to guarantee fees (other SBA loan programs have different fees). What this means is that if you cannot pay back the loan, the SBA certifies to the bank or lender that they will cover a portion of the lender’s losses. For instance, if you take out a $100,000 SBA 7(a) loan and the SBA backs 85% of this loan, this means that the SBA will cover your bank’s losses up to $85,000. Because the SBA is taking on this risk, the administration charges a guarantee fee to your lender. Your lender has the option of passing this fee onto you, which most lenders do. The guarantee fee will be included in your loan and will be deducted from the loan funds before they are disbursed to you. Click here for more information regarding SBA Guarantee Fees.
Offer in Compromise
An SBA offer in compromise (OIC) is a proposed settlement to pay a reduced amount of the debt owed. You will submit a proposal to settle the debt and provide evidence, which includes business and personal taxes as well as a complete list of your assets and debts, to back up this proposal as said by Business.com. The offer you submit must be fair and reasonable, meaning that you need to be able to repay what you are proposing.
You will submit the offer in compromise to your lender first. If your lender approves the offer, they will send it to the SBA for approval. Both the lender and SBA must agree to the terms of the proposed settlement (unless the file has been referred to the SBA, in which case it only needs SBA approval). If you are rejected by the SBA, the administration may allow you to submit another offer or they may send your debt to the U.S. Treasury Department for collection under the Treasury Offset Program.
Value Penguin states that if your debt is sent to the Treasury Department, you should be aware that they can collect using intrusive recovery methods, which include garnishing your wages, Social Security benefits or other retirement benefits, offsetting your bank accounts, and withholding any federal income tax refunds. As this is federal debt, the Treasury does not need a judgment against you to collect money in this way, and there is no statute of limitations on how long they have to collect. While you can settle with the Treasury, it is often difficult to do so, as the Treasury will most likely want to settle at a higher amount than the SBA. It can also be hard to find the appropriate contact at the Treasury with whom to begin the settlement process. Therefore, you should tread carefully before trying to deal with the Treasury Department as they will be more difficult to handle than the SBA or your bank lender.
Bottom Line – What you can do during default
Defaulting will harm your credit score which makes it harder to borrow money in the future and can even lead to business and personal bankruptcy. Before you ever borrow money, make absolutely sure you have a reliable plan for paying the loan back. Fundera suggests you seek the help of a debt counselor, cut back on spending, and find ways to ensure that you are more in control of your finances in the future.
Before you miss a payment, the best thing you can do is talk to your lender, according to Value Penguin. You may be able to negotiate a temporary deferment of your loan payments or a modification to your loan. If you miss a payment, it will be much harder to negotiate for these concessions. However, it is still recommended you contact your lender to settle the debt before it’s sent to the federal government.
If you have already received the 60-day notice letter from the SBA, you should act swiftly to put together an offer in compromise. The last thing you want is for your debt to be sent to the Treasury for collections. The offer in compromise you put together should address the debt owed and provide a reasonable plan that you can uphold. In some cases, it may be helpful to seek the advice of an attorney who specializes in debt settlement. They may be able to help you craft a good settlement offer that will have a better chance of being approved by your lender and the SBA.
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