LOANOLOGY

Risk & Defaults

Facing challenges in repaying your SBA loan can be daunting, but understanding defaults and proactive strategies can help you avoid severe consequences. Whether you’re managing a small business or franchise, LoanBox equips you with the tools and expertise to navigate late payments and maintain loan compliance. Below, we outline key terms and strategies to prevent defaults, ensuring your business stays on track.

Charge-off:

When a loan is categorized as a "charge-off", it means that the lender has officially classified your defaulted loan as an uncollectible debt. Although the loan is written off from the lender’s active portfolio, borrowers are still legally responsible for repaying the outstanding balance and any accrued interest. The lender or a collection agency may pursue debt collection efforts, and the charge-off remains on your credit report for seven years, potentially affecting your future borrowing ability.

A charge-off occurs when a lender classifies a defaulted loan as uncollectible, writing it off their active portfolio.

  • What It Means: The lender considers the debt unlikely to be repaid, but you remain legally responsible for the outstanding balance, accrued interest, and collection costs.

  • Consequences:

    • The charge-off appears on your credit report for 7 years, significantly impacting your ability to secure future financing.

    • Lenders or collection agencies may pursue repayment through legal action or debt collection efforts.

Default:

This term indicates that you've missed several loan payments, typically exceeding 60 days, putting your loan into a state of delinquency. This can lead to serious consequences, such as your lender demanding immediate repayment, accelerating the loan maturity, or even seizing collateral. Defaulting on a loan can significantly impact your credit score and hinder your ability to borrow future funds. However, it is possible to negotiate with the lender to resolve the default through a payment plan or loan modification.

A default happens when you miss multiple loan payments, typically exceeding 60 days of delinquency, per SOP 50 10 8.

  • What It Means: Your loan enters a state of non-compliance, triggering serious repercussions:

    • Lenders may demand immediate repayment of the full loan balance (loan acceleration).

    • Collateral, such as business assets or real estate (required for 7(a) loans over $350,000 with 25%+ equity), may be seized.

    • Your credit score takes a significant hit, limiting future borrowing.

  • Timeline:

    • 30 Days: Missed payments mark initial delinquency, prompting lender outreach.

    • 60 Days: Most lenders escalate to full collection mode, potentially involving external counsel or demand letters.

Avoiding Loan Defaults

Preventing defaults on SBA or conventional business loans requires proactive measures and consistent engagement with your lender. LoanBox helps you implement effective strategies to stay ahead of payment challenges.

Rule #1: Communicate Early and Often

Consistent communication with your lender is essential to avoid default, as both parties benefit from maintaining loan repayment.

Why Communication Matters:

  • After 60 days of delinquency without contact, lenders may assume the worst, escalating to demand letters or legal action, which are often avoidable with early dialogue.

  • Sharing challenges upfront, even if unfavorable, builds trust and encourages cooperative solutions.

  • Example: Informing your lender about a missed payment and outlining steps to secure new revenue can lead to flexible arrangements.

How to Communicate Effectively:

  • Act Promptly: Reach out before missing a payment, ideally when financial difficulties emerge.

  • Prepare a Plan: Explain your financial situation, reasons for payment issues, and propose solutions like payment adjustments.

  • Be Transparent: Provide accurate financial details to foster collaboration.

  • Negotiate Confidently: Highlight your commitment to repayment while remaining respectful.

  • Document Everything: Retain records of emails, call logs, and agreements for future reference.

SBA vs. Conventional Flexibility:

  • SBA loans may offer relief options like deferrals, though secondary market investors (common for 7(a) loans) may limit flexibility.

  • Conventional loans vary by lender, but proactive communication often unlocks similar accommodations.

Open Communication is Key
Don't wait until you miss a payment to reach out to your lender. If you anticipate difficulty making a loan payment, contact your lender as soon as possible. Explain your situation and explore potential solutions.

Be Prepared with a Plan
Before contacting your lender, have a plan in mind. Be prepared to discuss your financial situation, the reasons for payment difficulties, and propose solutions like loan modifications or temporary payment adjustments.

Be Honest and Transparent
Honesty is crucial throughout the communication process. Provide your lender with accurate information about your finances and be transparent about your challenges.

Negotiate with Confidence
While being respectful, approach negotiations with a degree of confidence. Highlight your commitment to repaying the loan and your willingness to work collaboratively to find a solution.

Document Everything
Keep a record of all communication with your lender, including emails, phone logs, and any written agreements. This documentation can be invaluable if you encounter any issues later.

#2 Rule: Stay Calm, You Have Options

Financial hardship doesn’t mean default is inevitable. Lenders offer workout options to help you avoid default, and staying calm allows you to explore these solutions effectively.

Available Workout Options:

  • Interest-Only Payments: Pay only interest for a set period to reduce monthly costs, preventing unpaid interest from accruing.

  • Loan Reamortization: Extend the loan term to lower monthly payments, though total interest may increase.

  • Loan Refinancing: If eligible, refinance at a lower rate or longer term to reduce payments.

  • Forbearance: Temporarily pause payments, with interest accruing, to provide short-term relief.

  • Loan Modification: Adjust terms, such as lowering the interest rate, extending the term, or deferring principal to the loan’s end.

  • Lender-Specific Deferments: Some 7(a) lenders offer custom deferments, evaluated case-by-case.

  • Repayment Extensions: Lengthen the repayment term to make payments more affordable, increasing total interest.

  • Collateral Substitution: Replace existing collateral with alternative assets to improve cash flow or adjust payment structures.

SBA-Specific Considerations:

  • Per SOP 50 10 8, SBA loan modifications require lender approval, with constraints for loans sold on the secondary market.

  • Collateral rules apply: loans over $350,000 often require real estate with 25%+ equity; Express loans ($50,000 or less) may skip collateral. A Home Equity Line of Credit (HELOC) can reduce personal real estate equity to avoid liens.

  • How to Proceed:

    • Engage your lender early to discuss options, presenting a clear financial recovery plan.

    • Leverage LoanBox to identify solutions that align with your business’s needs and lender policies.

LoanBox Loanology provides independent insights into small business lending based on what we know can be accomplished with most LoanBox lenders. However, there may be some policy, perspective, or viewpoint we share which may not reflect those of all lenders on our platform, as each brings unique policies. LoanBox lenders brings diverse policies and perspectives so not all lenders will be able to assist or even agree with all of the tips, strategies, articles, guides, and insights we provide for small business owner borrowers. Lenders are not responsible, liable or obligated for the content or advice provided in Loanology or on LoanBox.com. For specific guidance, use the search bar or just contact us directly and speak to a LoanBox Advisor.