What does it mean to default on a business loan?
Before a lender lends you a business loan, they will share some loan terms and conditions that you must agree to. If you fail to meet these agreed-upon terms after the loan is disbursed and don’t tell your lender in advance why you will be unable to fulfil your loan obligations, that is considered a default on your business loan.
There are two types of defaults: wilful and non-wilful.
- Non-Wilful Default: If you default on a loan because of circumstances out of your control, like a business deal gone bad, or losing your job, that is considered a non-wilful default.
- Wilful Default: If you are in a strong financial position and can repay your EMI but chose not to, that is considered a wilful default. This has lasting consequences on your credit score and your ability to get a business loan in the future.
What do lenders do if I default on a business loan?
If you fault on a secured business loan, the lender will initiate proceedings to foreclose the collateral you pledged as security in order to get the business loan. This allows the lender to take control of the collateral, which they can then sell to recover the losses associated with your business loan. It could also mean a dilution of your control over your business, or the loss of commercial or residential property or machinery, depending on what you used as collateral.
If you default on an unsecured business loan, lenders do not have any collateral to sell. In this case, they will charge you a late fee on your EMIs. But depending on the loan size, tenure, and interest rate, they may also begin legal proceedings to recover their losses. Then, they will follow the outcome of the legal judgment to recover the money they lent to you.
What are the consequences of defaulting on a business loan?
1. Drop in your credit score
Defaulting on a business loan gets recorded on your credit report and will result in a decline in your credit score.
2. Higher loan interest rates
Lenders check your credit report before they make a lending decision. The loan default mentioned on your credit report will indicate to a lender that you have been financially irresponsible in the past, making your business a higher risk for them. To reduce the risk they take, the lender may offer you the loan you need but at a higher interest rate compared to if you had not defaulted.
3. Increase in fees
In case of an unsecured business loan, as you have not provided any collateral in exchange for the business loan, lenders will charge a high late fee when you default on your loan terms. This may only be the first step they take to recover their losses and could be followed up with legal action as well.
4. Legal action
As mentioned above, depending on the type of business loan you got, the loan tenure, terms and amount, and the collateral you put up, the lender may start legal proceedings to recover the losses. Their first step will be to contact you to get you to pay the EMIs. If they are unable to contact you to reach an out-of-court resolution, or you do not have any assets for them to liquidate and recover their investment.
5. Foreclosure and liquidation of assets
In the case of a secured business loan, the lender will start the process of foreclosure to gain ownership of the collateral you put up against the loan. They will then sell the collateral to recover whatever money they lost.
6. More difficulty in getting a business loan in the future
Whether you went through a foreclosure, legal proceedings, or reached an out-of-court settlement with the lender, these will be reflected in your credit report and remain there for a few years. So, every time you apply for a business loan in the future, the lender will learn about the loan default from your credit report, which will make them think twice about lending to you.
To hedge against the risk of lending to you, they may offer you a smaller loan amount, require collateral for the loan, and/or offer you a higher interest rate. All of this is to ensure you will repay the business loan and they won’t lose money when lending to you.
7. Need to declare bankruptcy
If you are unable to repay the business loan, or your assets aren’t enough to cover the loan amount for the lender, you may have to declare bankruptcy in the worst-case scenario.
How do I avoid defaulting on a business loan?
- Ensure you always have a certain minimum bank account balance to pay your EMIs.
- Prioritize your debt payments with the help of a business cash flow forecast.
- Use automatic reminders to keep track of your payment schedule. Here are some Android and iOS apps to help you.
- Communicate with your lender. Tell them you predict a reduction in cash inflow before your EMI payment is due so that they can work with you to come up with a solution.
- Refinance your business loan or reschedule your debt payments.
- In extreme cases, seek legal advice to know your options.
When you apply for a business loan with CreditEnable, we check your business loan eligibility by doing a soft pull of your Experian credit score. This pull has absolutely no impact on your credit score.
If you have defaulted on a business loan in the past, lenders may reject your business loan application which may further reduce your chances of getting approved for a loan in the future. So, instead of directly apply to a lender, getting rejected, and taking a hit on your credit score, we’ll do a soft pull of your credit score and tell you upfront if you do not meet our lender partner requirement.
If you don’t, we’ll suggest ways you can improve your creditworthiness to be approved for the business loan in the future.
Defaulting on a business loan is a serious financial matter, but there are ways to recover from it. Bouncing back from it may be a slow process and requires you to practice strict financially responsible behaviour, but it is not impossible!
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