What Happens When You Default on a Loan?

Nobody takes out a business loan intending to default on it. However, running a business is unpredictable. Many issues can arise that can prevent a business from making timely repayments. Reasons can be personal or economic, and sometimes, the unexpected just happens.

There can be serious consequences when your loan defaults; you should understand the implications of not successfully repaying a loan before agreeing to take it out.

Read on to learn what happens when you default on a loan:

What is a Loan Default?

A loan default happens when you fail to make the scheduled repayments on a debt obligation for an extended period, violating the agreed terms of the loan contract.

If you miss a loan repayment by a few days, you will most likely not land in long-term trouble with many lenders, provided this is not a repeated behaviour.  However many business lenders will consider you in default if you miss a payment by a single day.

When a payment is missed most lenders will take several actions to try and avoid initiating a legal process.

Typical first steps from lenders are emailing, messaging, and calling to discuss the missed payment.  They’ll be seeking to understand why the missed payment occurred and make an arrangement .

If you truly cannot pay the loan despite all efforts, the lender can take escalating actions that can result in court action, loss of security, and a severely impacted credit file. 

What Happens When You Default on a Business Loan?

Defaulting on a business loan can have serious consequences, both for the business and its owners. Here are some of the key repercussions:

• Issuance of a Statutory Demand: The lender can issue a statutory demand, a formal legal notice that gives you up to 21 days to settle your outstanding debt before legal action is taken and the business is deemed insolvent.

• Winding Up of Business: Prolonged inability to meet debt obligations can lead to insolvency. This may result in the winding up of the business through the court. 

• Sale of Business Assets: The lender can start the legal process of selling your business assets as a mortgagee in possession. The lender will sell your properties until their losses are covered.

• Personal Liability: The guarantor for the loan, usually the business director, will be liable to pay whatever cost is not covered by selling business assets. 

• Disruption to Business Operations: Losing essential assets, like machinery, can severely disrupt business operations and impact revenue generation. If the security is directly tied to how the business makes money (e.g. a road freight business’s trucks), defaulting on a secured loan means a complete halt in business operations.

• Damage to Credit Rating: The business’s credit score will suffer, making it difficult to obtain future financing. The guarantor’s personal credit score could also be negatively affected. If your business does secure financing despite a record of default, future loans may come at higher rates and shorter terms.

• Operational Challenges: Defaulting on a loan can strain cash flow, making it difficult to meet other financial obligations. Additionally, relationships with suppliers, vendors, and other stakeholders may be damaged as your business’s reputation takes a hit.

• Bankruptcy and Business Closure: As a last resort, if your business cannot meet its debt obligations, you might file for bankruptcy. Bankruptcy can provide some relief but also involves a formal process and long-term impacts on your creditworthiness.

Avoiding Loan Defaults

Defaulting should always be an absolute last resort. This outcome is something neither you nor your lender wants, so you have lots of options to avert it. Here are some actions you can take to avoid going into default:

1. Communicating Proactively with Lenders

As soon as you anticipate trouble making payments, talk to your lender about getting temporary relief. Most reputable lenders are willing to work with struggling borrowers to avoid defaults. Through open communication, here are some solutions you can ask for:

• Loan restructuring: Extending the repayment period, reducing the interest rate, or altering the payment schedule
• Repayment Holiday: Negotiating a payment holiday, a period during which no payments are required
• Extended Grace Periods: Extending the grace period before payments are required, providing more time to stabilise the business.
• Waiver of Fees: Waiving or reducing late fees, penalty charges, or other fees associated with the loan

2. Refinancing or debt consolidation

If you’re struggling to make repayments, you can consider refinancing. This involves taking out a new loan to pay off and replace the delinquent one, potentially at better rates. You can also consolidate all your debts, like lines of credit, term loans, and tax debts, and pay them off with a single loan with better terms.

3. Improve Business Finances

Take steps to improve your business’ finances to increase income and manage repayments. You can do this in conjunction with a repayment holiday or deferment. While you’re not making repayments, do what you can to increase cash flow, including:

• Implementing strategies to increase sales (promos, discounts, etc.)
• Collect unpaid invoices from customers
• Enhance efficiency in your daily operations
• Cut non-essential costs and reduce spending to just the essentials
• Negotiate with suppliers for better terms
• Sell off other unused or non-essential assets to generate cash

4. Seek professional advice

If you’re in a very risky situation, it helps to consult different financial professionals to help you find a solution. You can look for debt counsellors or experts in insolvency to understand your rights and make informed decisions. You can also consult loan experts like Dark Horse Financial for advice on refinancing, restructuring, or debt consolidation. The key is taking action quickly before accounts slip into default status and fees, penalties, and legal exposure rapidly escalate.

Recovering from Default Consequences

While defaulting can feel devastating, it is possible to recover over time by taking the right actions. Here are some ways to do it:

• Pay off or settle outstanding debts to reduce the debt burden and improve credit scores.
• Focus on clearing delinquent debts before taking on new financing.
• Make all future payments on time to demonstrate improved financial management.
• Develop and adhere to a strict budget to control spending and manage resources effectively.
• Maintain open and honest communication with creditors, suppliers, and investors about the recovery plan and progress.
• Demonstrate commitment to fulfilling obligations and restoring financial stability to regain trust.