What Happens When You Default on a Business Loan & How to Avoid it?

Anne E. Evans
What Happens When You Default on a Business Loan & How to Avoid it?

Business loans, or any loan for that matter, are given in good faith. The lender considers a number of eligibility criteria before sanctioning a loan to the borrower. The borrower bears accountability to repay the loan in a timely manner, as per the terms of the loan. 

Despite the stringent eligibility checks, due to unforeseen circumstances, the borrower may be unable to repay the loan in a timely manner, resulting in defaults. Defaulting on a loan carries many adverse effects to the credibility of the borrower. It lowers the credit score of the borrower and makes it difficult to avail loans in the future.  

What is a Business Loan Default?

Business loans are credits offered to meet various business financial needs like working capital, trade finance, revolving credit with the bank, bank guarantees, letters of credit and more. They can also be in the form of term loans from time to time to acquire assets or purchase raw materials.

A loan default happens when the borrower fails to honour his promise to repay the loan or EMI on the agreed upon date. Even if you might sincerely hope to pay back the loan on time and in full, unexpected circumstances might stall your operations. When your company runs into financial difficulties, you could struggle to pay back the instalments. For your organization and your credit history, it may have significant implications.

What are some of the consequences of defaulting on your Business Loan?

Though defaulting on a loan is a non-criminal offence, non-payment for a long period of time may result in legal action against the defaulter. This is recorded against your credit history and may cause problems to avail any kind of loans, credit cards or credits in the future.

Here are some of the consequences of defaulting on your Business Loan: 

Impact on your Credit Score: The major impact of defaulting on a business loan is the adverse effect on your credit score. Your credit score is an important criteria to avail any kind of credit with a bank or NBFC. Your credit score reflects important information relating to all your present and past credit history. On-time payments constitute the biggest factor of your credit score. When you default on a business loan payment, the credit score of your business takes a significant hit. 

Your credit score reflects your credibility and is an important deciding factor for banks and NBFCs to sanction any loan. When defaults are reflected on your credit history, it reduces your credit score. This has a negative effect on your future loan prospects. 

Impact on Future Loans: As most loans depend on your credit score, defaulting will result in lower credit score, impeding your future loan prospects. You may then have to look for non-conventional loan avenues which are, for one thing very costly and secondly, not very reliable. 

Impact on Interest Rate and other Loan Terms: Your loan interest rate and other terms are mainly dependent on your credibility. Defaulting on a loan impacts your credibility resulting in higher interest rates and tougher loan terms on your future loans. 

Legal Action: Prolonged non-payment of loans may result in legal proceedings against you by the lender. This will cause unwanted stress and personal agony for the borrower. 

Some lenders may even initiate foreclosure proceedings against the borrower. A foreclosure would give the lender full authority over all of your assets and properties specified as collateral in your loan agreement in a secured loan. Generally, in a private or public auction to recover their losses, they sell the collateral. The lender usually levies a late fee in the case of an unsecured loan. Even in the case of an unsecured loan, however, the lender needs a personal guarantee or a lien on the assets of your company. Therefore, the lender will file a complaint against the company for further failure.

Bankruptcy Filing: In case you are unable to repay the loan even after the lender has taken over your assets and properties, they may choose to file bankruptcy proceedings against your company. 

Simple but Effective Tips to Prevent Defaulting on your Business Loan

Defaulting can be easily prevented through prudent management of your money. Here are some simple tips for you: 

Plan your expenses: Planning your finances is very important for your business. Keep track of all the purchases and expenses to avoid leakage. Keep a note of all the EMI dates and ensure that your bank account has sufficient balance to meet all the EMIs. Be careful with your profit spending. Make sure that you have accounted for all the repayments before you spend your profit part. 

Use your less profitable investments to pay off that loan: If you have any FDs or other investments that are not earning you much returns, divert them towards your loan repayment. This will reduce your interest burden and enable you to meet your EMI demands effectively. 

Talk to your bank: If you find yourself overwhelmed with your loan repayment management, don’t hesitate to approach your bank for re-negotiations. Your bank has the power to modify your loan terms to allow comfortable repayment for you. Opt for debt consolidation if needed. Ask your bank for all available options so that you can restructure your loan and avoid defaulting. 

Don’t hesitate to seek legal help: Though you are the borrower and are accountable for the repayment, you too have some rights as a consumer. So, if the bank threatens any legal action against you or your company, immediately seek legal counsel. Find out all the possible legal courses of action to douse the situation. 

Few Words of Financial Wisdom

Running a business is a gamble. You are dependent on so many factors for the success of your enterprise. You have to seek financial help from banks and NBFCs to meet various expenditures of the business. Though you take a loan with good faith and absolutely hope to pay it back, there may be things out of your control when it comes to business. So, to avoid defaulting at any cost, make sure that you have a solid financial plan. 

Keenly observe the income and expenses of your business so that you are able to meet all your liabilities while enjoying a considerable profit. Don’t hesitate to ask for help when you have even a slight doubt that you might be running into trouble. Paying off liabilities should take precedence over diverting profit to other needs. 

Talk to your bank. Your bank can do many things to help you with your loan. Lay down all your available options on the table and take the most prudent course of action. Happy Entrepreneuring!! 

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