What does it mean to default on a business loan?
When you fail to meet the agreed-upon terms of your business loan without prior communication with your lender, it is considered a default on your loan. There are two types of defaults: wilful and non-wilful.
A non-wilful defaulter is genuinely in debt and unable to repay their EMIs due to unforeseen circumstances like lost employment or a bad business deal.
A wilful defaulter has the financial ability to repay their loans but purposefully chooses not to repay the lender because of one or more of the following reasons:
- Not making payments even though they have positive cash flow and have a good net worth.
- Siphoning funds
- Misusing the borrowed amount for reasons other than those for which the loan was given
- Falsifying information
- Conducting fraudulent transactions
- Removing securities without their lenders’ knowledge.
What happens if I default on a business loan?
Once you default, depending on the type of business loan, the loan amount, tenure, and your relationship with your lender, they can start legal proceedings to recover their investment.
In the case of a secured loan, or a loan against some form of collateral, the lender will foreclose the collateral you pledged in a private sale to be able to recover the amount they lost. In case of an unsecured loan, lenders will charge you a late fee, and depending on the loan size and terms, may take legal action against you and recover their losses based on the legal judgement made.
When you default on a business loan, it is recorded on your credit report and remains there for the next 7 years. This means when you apply for another business loan in those 7 years, lenders will consider you a higher-risk business and may choose to not lend to you or offer you a higher interest rate and more stringent loan terms.
How do I avoid defaulting on my business loan?
1. Always maintain a certain minimum bank account balance:
We are operating in a volatile market right now, and you never know when your cash flow may decline or when your supply chain may be disrupted. To overcome such unpredictable hurdles outside your control, always ensure you have a certain amount in your bank account that is enough to pay your EMI instalment. This is also a good way to help manage your finances and prioritize your debt payments.
2. Prepare a cash flow forecast for your business:
A cash flow forecast is a great way to predict what your cash flows will look like in the coming year based on your past income and expenses. It helps you organize your payments, see patterns in income and expenses, and identify areas of improvement or income diversification that you can capitalize on. A cash flow forecast will also help you prioritize your debt payments.
Learn more about cash flow forecasts and ask your CA to help you prepare one day!
3. Set automatic reminders to keep track of your payment schedule:
One of the easiest things to do to stay on top of your EMI payments is to set a monthly reminder on your phone, email, etc., to prompt you to make the upcoming payment before its due date.
4. Communicate with your lender:
We can’t stress this enough! Communication is key when it comes to business loans. Your lender is invested in your business and wants to see it do well. If you feel like your cash inflow this month is low or that you may face issues making an EMI payment, talk to your lender ASAP. If they know what is going on, they will help you find a solution and may even adjust your EMI payment schedule to help you stay on track. This may slightly impact your credit score, but it is a better alternative than defaulting.
5. Refinance your business loan
Check if your lender will allow you to refinance your business loan at a new interest rate and payment schedule or by altering other loan terms that both parties previously agreed upon. Remember, business loan refinancing is a temporary solution, not a permanent one.
6. Reschedule your debt payments
If your business expenses are hard to keep up with, you can approach your lender to reschedule your EMI payments. This means your lender may be able to revise your business loan interest rate and increase your loan tenure so that you can make smaller EMI payments for a longer time. Rescheduling your debt payments will make them more manageable but will impact your credit score.
7. Seek legal advice
Finally, if things get unmanageable, and you foresee no other way out but defaulting on the loan, seek a legal professional to know your rights and the legal implications of defaulting on your business and your credit.
If you have defaulted on a business loan, learn how to remove your name from the CIBIL defaulters list.
Your goal is to avoid defaulting on a loan, so pre-emptive action is critical when you take a business loan. Predict when you will be unable to meet the loan terms and talk to your bank to find a solution to your problem together.
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