What happens when you default on a business loan?

Running a business is fraught with risks and unpredictability. Every year, consumer preferences, governmental policies, and industry trends change while market competition increases. Thus, you cannot be certain that your revenues will remain the same, let alone increase, in the future.

Revenue decline and losses are part of the business cycle. But what if you suffer a loss while carrying the burden of a business loan? What if the loss is so severe that it results in a loan default? This article will answer all your concerns related to business loan defaults.
 

Common Reasons for a Business Loan Default  

• Environmental disasters

  They are the most typical cause of loan default, particularly if your company is in a disaster-prone region. You might have to temporarily close your business if a natural disaster like an earthquake or flood strikes. It is also possible that such a catastrophe damages your company's facilities. In both scenarios, your firm will experience an income loss, resulting in a potential loan default.

• Social unrest

  Events like rioting, political instability, and even religious gatherings can have a negative impact on your business operations. In such times, it may be challenging for your company to generate revenue, increasing the possibility of defaulting on your business loan.
   

• Government policies

  Another cause of business loss and loan default is a sudden change in government policies and regulations that can affect your business directly. For instance, increase in taxes on some products might reduce their market demand and cause losses for the manufacturers.
   

• Fraud

  Business owners can be defrauded by their own employees, partners, and customers. When the amount of fraud is too high and cannot be recovered, businesses may find it difficult to continue operations and default on their loans.
   

What Happens if you Default on an Unsecured Business Loan?

 
Unsecured loans are term loans with three-year payback period and loan value of up to Rs 25 lakhs. Here is what happens if you default on such business financing products. 
 

1. Drop in credit score

   The very first business loan default consequence is a decline in your credit score. Every single transaction you make in relation to loan products is recorded by credit bureaus. They immediately update your credit report when you skip an EMI or default on a loan. As a result, a lender will come to know about your previous defaults when you apply for a loan in the future and reject your loan application.
    

2. Increase in charges

   Every skipped EMI on your loan results in a penalty. Moreover, if you default on a loan and then apply for a consumer-durable loan in future to improve your credit history, you cannot obtain the loan on advantageous terms. The previous loan default will be there on your credit report for a long time. As such, you will not be getting a loan at low interest rate any time soon, regardless of how diligent you become with your future loan payback.
    

3. Legal action

   Many people believe that missing a payment on an unsecured loan will only hurt their credit rating. However, this is not the case. There is also a provision for legal action against loan defaulters in India. The lender will initially charge you a late fee. However, if you continue to fail in paying back your debts, lenders will take you to court to recoup their losses. There is also a chance that you could lose your personal assets in an auction held by your lender if the court warrants action against you.
    

4. Bankruptcy

   As previously stated, when you default on your business loan, the lender may take legal action against you. In such an instance, you will have to make the repayment in accordance with the terms and amount decided by the court. If you still fail to repay your debt, you will have to declare yourself bankrupt. 
    
   Bankruptcy has a severe impact on your career and business prospects. It might be extremely challenging for you to start a new company in the future. Additionally, it will be difficult for you to rent an apartment or find a job, among other things.
    

Also Read: How To Repay Business Loan If Business Is Incurring Losses
 

What Happens if you Default on a Secured Business Loan?

Secured business loans include equipment financing, working capital loans, etc. Defaulting on such loans results in the following scenarios:
 

1. Seize of assets

   Do you know why lenders offer a low-interest rate on a secured business loan? It is because their money is secured if you do not pay back your obligation. Under secured loans, lenders have the right to seize your pledged assets and recover their losses from it. Suppose you purchased medical equipment of Rs 20 lakhs. You put Rs 5 lakhs as a down payment and financed Rs 15 lakhs through a medical equipment loan. In this case, if you default after paying Rs 7 lakhs of the principal outstanding balance, the lender will auction the purchased equipment to recover the remaining balance. However, if the equipment gets sold for any amount in excess of the unpaid dues, the surplus amount will be paid to you. 
    

2. Guarantor's obligation

   It is possible that you failed to meet one of your lender’s basic qualification requirements when applying for a business loan. In this situation, the lender may ask you to include a co-applicant or offer a loan guarantor on your loan application. If you chose a loan guarantor at that time, they will be held accountable for paying the outstanding debts on your behalf if you default.
    

How can I Avoid Defaulting on a Business Loan?

 
You may avoid getting into a debt trap by taking any of the following measures: 
 

• Automate payments

  In case you have a habit of forgetting important dates, especially EMI due dates, automate your payments. Under this, the specific amount will be deducted from your account automatically and you will receive an email or SMS notification for the same.
   

• Refinancing

  You might be approved for a high-interest loan during the initial years of your business. But now that you are consistent with your EMI payments, you might look for business refinancing to lighten your financial burden. Refinancing allows you to transfer your existing debt to a new lender on a lower business loan interest rate and at better terms. 
   

• Debt rescheduling

  If for any reason, you are having trouble paying your debts, it is better to speak with your lender than risk damage to your credit score. Under debt rescheduling, your lender may agree to extend the repayment tenure. In some cases, where you have a strong relationship with the lender, they may occasionally relax the terms of the loan by, for example, waiving a portion of the interest component.
   

• Use emergency reserve

  Maintaining an emergency fund to deal with uncertainty is advised for everyone, regardless of whether you are a business owner or a salaried employee. Reserves assist in paying off debt or paying suppliers when your business is facing financial difficulties.
   

• Increase EMI

  Another way to get rid of a business loan and avoid a situation of default is by paying increased EMI. When running a business, there may be times when you make unforeseen gains when things are going exceptionally well. At these times, instead of paying the same EMI, you can increase the amount considerably. It will help you pay off debt earlier, avoid prepayment penalties, and save on the interest component.
   

Also Read: How to Improve the Credit Score for your Business
 

To Conclude

 
A business loan default damages your reputation, limits your ability to borrow money in the future, and can force you to file for bankruptcy. If you have a secured loan, the lenders can auction your pledged assets to recoup their losses. However, you can avoid such situations by opting for a loan rescheduling or refinancing with your lender. Even the lenders would be willing to strike a deal with you instead of facing hassles of legal options or auctioning your assets.