Before you decide on securing a business loan through the SBA, you should understand what happens to the loan in the event that your company goes out of business.
In this article, we’ll explore what you need to know so you can plan ahead before securing an SBA loan.
Do You Have to Pay Back an SBA Loan if Your Business Closes Down?
If you’ve taken out an SBA loan, the lender and the SBA will want their money back whether your business goes under or not. Therefore, in the event that your business does close, you’ll need to keep making payments. If you’re unable to make payments, you’ll default, and then it’ll be up to the lender and the SBA to get the money they’re owed.
Defaulting
When you default on a business loan, the lender and the SBA will work together to get their money back, but the SBA defers to the lenders they work with in most cases. After all, there are millions of SBA loans out there, and the agency can’t play a hands-on role in every case.
Lenders use a variety of methods to get back the funds they’re owed, including bank levies, wage garnishment, repossession, and foreclosure. A lender could even get law enforcement involved, and while this is uncommon, it certainly can happen if you’re trying your hardest to prevent seizure of your assets.
The scariest part about defaulting on an SBA loan is that your home could be seized and sold, because most lenders require borrowers to pledge their homes as collateral. And once a home is pledged, getting it released can be quite difficult, even if you’ve made repayments consistently for years.
So before you take out a loan through the SBA, think long and hard about the collateral you’re willing to offer up, as it can be seized if unexpected financial hardship forces you to default.
Collateral
In order to be approved for an SBA loan in most cases, you’ll need to offer up collateral, unless the loan is for $50,000 or less. Before an asset can be accepted as collateral, it needs to be appraised by the lender so they have a better understanding of the asset’s value.
Lenders require collateral so they can recoup all or most of their losses in the event of a borrower defaulting. The process for seizing collateral is outlined in the loan agreement, so it’s incredibly important to understand this before signing on the dotted line.
In most cases, 80%-100% or more of the loan’s value will have to be backed by collateral.
What’s acceptable collateral varies from lender to lender, but usually borrowers put up property, vehicles they own, money in bank and investment accounts, collectables, and other valuable items as collateral.
If your loan was specifically for purchasing commercial property or equipment, the lender will seize and sell what you purchased to recoup their losses. In most cases where this happens, the borrower still has to pay a balance, as usually commercial property and equipment sell for less than what they were purchased for.
But even though a lender has the right to seize and sell your collateral in the event of default, they’ll still need a court order before they can enter your home or business and start taking away your assets.
Personal Guarantee
In addition to putting up collateral, you may also have to sign a personal guarantee, in which you agree that the lender can seize and sell your personal assets in the event of default. This is particularly relevant when your business shuts down before the loan is paid back, as the chances are the business won’t have any assets when it’s closed.
A personal guarantee is different from collateral in that the former allows a lender to seize and sell assets that weren’t originally at risk, whereas collateral is willfully put at risk in order to secure the loan.
In most cases, a lender will take whatever they can to satisfy the debt, though there are a few restrictions. For example, if your household has one vehicle, they won’t always seize it. But if you have more than one vehicle, the extra vehicles will probably be seized and sold.
Does the SBA Forgive Loans?
The SBA will never fully forgive 7(a) and 504 loans, but in most cases they go along with settlements that have been reached by lenders and borrowers.
In fact, they have a settlement program, SBA Offer in Compromise, for businesses with debt that are no longer operating and unable to meet their repayment obligations.
Of course, not every company that goes under with outstanding debt is eligible for this program. Here are the requirements your business would have to meet:
- Your business needs to be closed and its assets liquidated.
- You’d have to submit full financial disclosure.
- It’s likely that you’ll be able to repay your debt over a reasonable period.
If you’re accepted into the OCI program, your loans will be closed and the SBA will stop attempting to collect the debt.
But just because you’re accepted into the program doesn’t mean you’ll get a good deal, and that’s because standards and practices vary by region. Knowing this ahead of time is critical, as you should never assume a favorable settlement is guaranteed.
SBA Loan Forgiveness Dos and Don’ts
- Do: Be totally honest about your current financial situation and give the SBA the documents they’re looking for. If you don’t, they won’t be willing to negotiate.
- Do: Expect to pay. An OIC program is not a free ride, and the SBA isn’t required to make deals. If they suspect you’re trying to skirt responsibility, they won’t make a deal and they’ll seize what they can instead.
- Don’t try to go over your lender’s head. The SBA will defer to the lenders they work with in most instances, so it’s best to work something out with both entities.
- Don’t try to hide assets, income, etc. from your lender or the SBA. Not only will you be denied a settlement but they’ll probably use the most aggressive collection methods to get what they’re owed.
Defaulting on an SBA Loan vs a Conventional Business Loan
Defaulting on an SBA Loan
Once you’ve defaulted on an SBA loan, the lender you’re working with will take possession of the collateral you put up to secure the loan. If you didn’t put up any collateral, but you signed a personal agreement, they’ll get a court order which allows them to seize your personal assets.
If the loan wasn’t secured by collateral, and if there are no valuable personal assets for them to seize, the lender will file a claim with the SBA to get the portion of the loan that’s guaranteed.
When the lender gets compensated, the SBA essentially takes over and pursues the funds they’re owed from the borrower. They’ll send out a letter which details the current situation as well as next steps, and if the borrower doesn’t respond within 60 days their account will be transferred to the U.S. Treasury Department.
If the borrower does respond within the time frame given, there’s a chance they can be enrolled in an OIC, in which case they’ll only have to pay a portion of what’s owed to the SBA. If they don’t respond, and their account goes to the Treasury Department, a variety of collection methods will be used to get the owed money, including wage garnishment, bank levies, and tax refund offset.
Defaulting on a Conventional Loan
If you default on a conventional business loan, your business and personal credit scores may drop sharply right away. Additionally, the lender may demand you pay the whole loan back immediately, and you may also be saddled with a penalty interest rate.
If you don’t pay the full amount back within the time given, the lender will use a variety of methods to get their money back.
Most business loans are secured with collateral, but some borrowers do manage to get unsecured business loans.
If you default on a secured loan, the lender will seize and sell your collateral.
If it’s unsecured, there’s no collateral for them to seize, but this is where the personal guarantee comes into play. The lender would have to take you to court to get control of your assets, and they could even add the cost of going to court to your outstanding debt.
What Happens if You Default on an SBA Disaster Loan
A Covid-19 Economic Injury Disaster Loan (EIDL) is a specific kind of loan that many small businesses took out during the 2020 Covid-19 pandemic. These loans are like standard 7(a) loans in many ways, and in the vast majority of cases they must be paid back in a reasonable time frame.
If your EIDL loan was for less than $25,000, there’s a chance the SBA may forgive the whole thing in the event of default, especially if it was unsecured. However, as a borrower, you shouldn’t count on this happening, as most of the time the SBA and the lenders they work with will pursue the money they’re owed.
What Happens if You Don’t Respond to the SBA
Once you’ve defaulted, the SBA and the lender you’re working with will start sending notices and making phone calls in an effort to collect the debt. It can be tempting to avoid both entities, but doing so will only hurt you in the long run.
After all, loan forgiveness is not a right, so if you refuse to cooperate with your lender when they’re trying to assess your current financial situation, they may refuse to cooperate with you when you want to be enrolled in an OIC program.
And if you want to save your credit scores from taking a dive, you could discuss the possibility of being enrolled in an OIC program before defaulting, but there’s no guarantee that your lender will allow this, even if you’ve been consistently responsible and cooperative. Usually lenders wait for a string of missed repayments before discussing forgiveness with borrowers.
Also, you could hire an attorney to deal with your lender and the SBA for you, but in most cases it’s cheaper to just handle things on your own.
Final Thoughts
The bottom line is: if you close your business before the loan you took out is paid back, you’ll still be responsible for the money owed. If you’re forced to default because you can’t make repayments, there’s a good chance you’ll have to forfeit your collateral and maybe even some personal assets, unless you and your lender can reach a repayment settlement.
Key Takeaways
