When you are unable to fulfil the terms and conditions of your business loan, for more than 3 EMI, without informing your lender, it is considered a business loan default.
When you get a business loan, your lender puts forwards some terms and conditions on how and when you need to repay the loan. You must agree to these terms to get the loan. Read on to understand the consequences of business loan default and how to avoid it.
What are the different types of business loan defaults?
In circumstances when you are unable to abide by the terms and conditions because of reasons that are out of your control, it is considered a non-wilful default. Like when your business has run into a loss, or you lose your job, or for any unforeseen reason that affects your financial situation in a way that you are not able to repay your EMI, you are considered a non-wilful defaulter.
On the other hand, if you have the financial ability to repay the loan and willingly ignore the terms and conditions of your business loan, you are considered a wilful defaulter. A wilful default happens when you:
- Are financially stable and still refuse to repay your loan
- Siphon your funds
- Misuse the loan amount by using it for reasons other than the one you stated while taking the loan
- Falsify information on your loan application
- Conduct fraudulent transactions
- Remove security without informing your lender
What are the consequences of a business loan default?
The consequences of your loan default depend on the type of business loan, the loan amount you have borrowed, and your relationship with your lender. Here are some of the consequences you could face if you default on a business loan:
1. Drop in your credit score:
When you default on a business loan, it gets recorded on your credit report, which results in a decline in your credit score, making it difficult for you to get funding at favourable terms from a formal lender in the future.
2. Higher loan interest rates:
If you apply for a business loan in future and the lenders will check your credit report, they will catch the loan default on your credit report. It may indicate to the lender that you are financially irresponsible or that your business is in a cash crunch. Both reasons may reduce the lender’s trust in you and your business. So, to reduce the risk they would take on by lending to you, the lender may offer you a business loan with a higher interest rate.
3. Increase in loan fees:
If you default on an unsecured business loan, your lenders do not have any collateral that they can use to recover their losses. So, the lender may increase the fee or penalty on your next loan EMI instead to recover the money you owe them. Your lenders may also start legal proceedings against you to recover their losses if you owe them a substantial amount.
4. Legal action:
When you default on a business loan, lenders will try to contact you to pay the EMIs. They will then use the EMI cheques you gave your lender at the time of loan disbursement to recover the money. If they are not able to contact you or the EMI cheques bounce, and you don’t have any assets for the lenders to liquidate, your lender may start legal proceedings against you to recover the money you borrowed from them.
5. Foreclosure and liquidation of assets:
When you default on a secured business loan, your lender can start the process to foreclose and liquidate the assets you put as security against your secured business loan. If you have put up a residential property as collateral on your business loan, it may result in the loss of your property. Similarly, you can also lose control of your business if that is what you used as collateral.
6. Difficulty in getting a business loan in the future:
A business loan default gets recorded on your credit report. Moreover, any legal action or foreclosure will be reflected on your credit report and impact your credit score. So, every time you apply for a business loan in future, the lender will learn about your defaults from your credit report and may not feel confident about lending to you. As you approach more lenders for business funding and they pull your credit report and then reject your application, these hard pulls will also be recorded on your report, further bringing down your credit score.
7. Need to declare bankruptcy:
If you are not able to repay the business loan and your assets are not enough to cover the losses of your lender, you may have to declare bankruptcy in the worst-case scenario. A declaration of bankruptcy will again be recorded on your credit report and further reduce your chances of getting a business loan at favourable terms in the future.
How can I avoid a business loan default?
Avoiding defaulting on your business loan is not as difficult as it may sound. All you need to do is pay your EMIs on time and stay in touch with your lender. Here are some other ways you can avoid a business loan default:
- Always maintain a certain minimum bank account balance so that you can pay your EMIs on time.
- Prioritize your EMIs by forecasting your business cash flow and allocating money to different business expenses.
- Set automatic reminders to keep track of your EMI payment due date.
- Maintain a responsible attitude towards your lender. If, for whatever reason, you are unable to repay your EMI on time, communicate with your lender and let them know beforehand so that they can come up with a solution that is beneficial to both you and your lender.
- Request your lender to refinance your business loan terms. You can also ask them to revise your loan interest rate and your loan tenor so it is more manageable for you to repay your loan on time.
- You can also seek a legal consultant to understand your rights and the implications of your business loan default.
Defaulting on a business loan has a direct impact on your financial image. You can recover from a business loan default by practising financially responsible behaviour for a few years, at least until the default has a less severe impact on your credit score.
When you apply for a business loan with CreditEnable, we will tell you upfront if you are not eligible for a business loan with one of our lender partners. Past defaults on business loans may make you ineligible however this can be assessed on a case-by-case base. If you have defaulted in the past, we will also recommend ways to improve your creditworthiness, so that you can become eligible for a business loan in the future.
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