For those looking to acquire outside funds for their small business, you may be wondering what actually happens if you default on your loan.
First off, defaulting on your loan simply means that you have not met your promised obligations to your respected lender agreed upon to pay back your loan. Exactly when you are “officially in default” depends on your particular lender. While some lenders consider a borrower to be in default after just one missed payment, other lenders might take months before seeking action.
Before acquiring your loan, confirm your lender’s definition and terms of a default.
Although all lenders are different, there’s a basic understanding of loan default guidelines that is consistent across all lenders. Here are some basics to what happens if you do get in hot water and are unable to pay back your debt. Below are the three top things that actually happen when you can’t pay back a loan.
1. Your credit score drops significantly
Pretty straight forward and expected. If you default on your loan, the credit bureaus will be notified and your credit score will take a hard hit. Because of this, it will be more difficult for you to acquire any future loans. If, however, a lender does choose to take on the risk, you will typically have much higher interest rates.
2. If applicable, collateral will be seized
Another one that’s pretty straight forward, if you put up collateral for a loan and you default, you will lose that collateral. In general, for secured loans, collateral is always needed to acquire one. If your loan is secured and you default, that collateral will be lost. If, on the other hand, you have taken out an unsecured loan, which doesn’t require collateral, and you default, multiple things can happen. First, many lenders will begin adding fees and increasing your interest rates. If they don’t receive any payments, they may turn your loan over to a collection agency. If the collection agency is unsuccessful with acquiring payments, the lender may take legal action, resulting in garnished wages or putting a lien out on your home.
3. Defaulting on a merchant cash advance or peer-to-peer lender
- Merchant Cash Advance: Since the lender technically purchased a portion of your future funds, you can go in and re-negotiate your payment terms if you are starting to feel overwhelmed by the daily percentage you pay. If your business closes, payments will end.
- Peer-to-Peer Lending: Defaulting on a P2P loan usually results in a chargeoff, or when the lender declares that they doubt you will ever pay, and so they remove the delinquent account from their books.
In order to avoid defaulting on your loan, it’s imperative that you remain proactive.
That means don’t try to ignore it, and definitely don’t try to hide it. Let your lenders know if you think you’re getting into trouble. Many times, the lender will try to work with you to renegotiate your terms, or even extend it. Lenders would rather be paid back later than expected than not be paid back at all.
Another popular consideration is loan consolidation and refinancing which is widely used by borrowers who need to climb out of debt.
Whatever the case may be, remaining in control of your finances is necessary to your businesses success. Have a solid system that you can keep up with, and if you do feel yourself on the verge of drowning, speak up before it’s too late.