Every entrepreneur reaches a point in life where they consider getting a business loan to either start a business or expand their business. So, when they take a loan, they have the best intentions to pay it off. But running a business is like being on a roller coaster ride with several ups and downs. If the business is caught in the whirlwind of unfavorable circumstances, it can have a major impact on its cash flow, and that can often lead to the failure of paying the monthly installments towards the loan.
What does a loan default mean?
When a borrower knowingly or unknowingly breaches any of the loan terms of the loan agreement, a loan default happens. It usually happens when a borrower fails to pay one or more of the installments on time, as agreed.
Default on a business loan can have a lot of repercussions. Below are a few consequences of defaulting on a business loan:
1. Credit scores take a hit
Each time a borrower defaults on the loan, the lender reports it to the credit bureaus. Multiple such entries in the credit report can significantly drop the credit score, making it difficult for the borrower to get a loan in the future.
2. Future loan approvals are at a high-interest rate
As mentioned in the earlier point, a low credit score decreases the chances of getting future loans. When deciding the business loan interest rate, lenders take the borrower’s credit score into consideration. If the loan is approved despite a low credit score, lenders will charge a very high-interest rate to minimize the risk involved.
3. Potential legal action
Depending on the type of business loan taken, there can be two loan default scenarios:
- Defaulting on a secured business loan: The lender can simply seize the collateral to repay the debt.
- Defaulting on an unsecured business loan: The lender cannot seize the assets because there was no collateral attached to the loan. However, the lender can increase the interest rate or charge a late payment fee. The lender can also sue the company to recover the balance amount.
The consequences of defaulting on a business loan can be extremely severe. Borrowers need to make sure that they keep these things in mind to avoid getting into major financial and legal trouble:
- Be aware of the repayment deadlines. Set reminders or auto payments if required.
- Be cautious while taking new loans. Accumulating more debt is an easy way to fall into a debt trap.
- Manage expenses and prioritize debt. Although simple, this tip is a building block of efficient financial planning.
- If the debt is uncontrollable, consider refinancing or debt consolidation. Getting a personal loan to consolidate debt is a good idea.
- Track business cash flow to ensure that money is always available to make the repayments on time.
- Contact the lender immediately if repayment is not possible. Be honest about the situation and propose a plan of action. If the cash flow fluctuation is a temporary blip, the lender may work with the borrower to rectify the situation.
- Seek legal assistance if required to know what rights you hold and what provisions you can access to deal with the situation.