What Happens When You Default on an Unsecured Business Loan?
Oct 12, 2019 03:53 PM EDT
At some point, most business owners decide to acquire additional finances to invest in their businesses. With a loan, they can update equipment, improve a storefront, or increase working capital to balance out cash flow.
Having sufficient finances to cover costs and unexpected expenses is paramount to business growth.
Most entrepreneurs prefer to get unsecured business loans because lenders don't require collateral to secure the loan. You can learn more about unsecured business loans in Camino Financial's article: Unsecured Business Loans vs Credit Cards.
But what happens if business owners default on one of these types of loans? First, let's find out why unsecured business loans are an attractive lending option.
What are unsecured business loans and how are they different?
When business owners don't need to pledge collateral, there's less risk for borrowers but more for lenders. Examples of collateral include real estate, cars, and equipment. Lenders also accept inventory, unpaid invoices, and cash in savings accounts.
Businesses just starting out don't have tangible assets to offer as collateral. That's why they turn to an unsecured business loan to gain access to capital quickly without jeopardizing losing valuable assets.
Because the lender doesn't have collateral to seize should you default on payments, you may need to meet other criteria. Lenders may require that your business earns a certain amount of revenue or that you've been in business for 2-3 years. Since the loan is unsecured, you pay higher interest rates because lenders consider you a higher risk.
Legal consequences when you fail to make payments
What happens when you default on an unsecured business loan?
As soon as you're 30 days late on a payment, a lender representative will probably contact you by phone or send a formal letter.
When you're over 60 days late, lenders typically refer your unpaid debt to a collection agency. What's even more damaging for your business is having the delinquency reported to the three major credit bureaus. Once your credit score drops, you'll have difficulty getting future financing.
If the collection agency fails to resolve the debt, lenders can sue your company for the amount you owe along with interest and late payment charges.
It's even possible you may end up paying fees, penalties, and lawsuit costs.
Depending on which state you live in, lenders can garnish wages or put a lien on your home. Lenders do not want to pursue legal action because they'd rather receive payments on time, however, this is a legal recourse they take when you fail to reconcile the debt.
Options to consider
Obviously, it's not in your best interest to default on a loan. Make sure you have sufficient cash each month to cover payments. Put aside a reserve of two or more payments in a savings account to fall back on should you have a cash flow deficiency. Work closely with your accountant or a financial advisor on ways to increase profit. Also, look at your expenses to see if you're overspending.
As soon as you realize you can't make a payment, contact the lender immediately. Be upfront about your financial situation. A lender will appreciate your honesty and is more inclined to work with you through this temporary setback.
Consider refinancing the loan to get better terms. You could also open a line of credit with your banking institution. Both of these options allow you to either pay off the older debt or become current without experiencing credit and legal consequences.
Signing up for a loan is a serious decision, especially when you could jeopardize the future of your business. As you can see, defaulting on your loan results in unfavorable circumstances. However, you can take steps to rectify the problem and keep your business moving forward.