But, that’s what I want to discuss with you today. The downside. But not just the downside in a general kind of way. I want to talk about a very specific downside: what happens if you default on an SBA loan, and how you can resolve it.
SBA Loan Basics
The internet is full of information about SBA loans, so I’ll spare you the book report. Instead, I’m going to highlight the key features of SBA loans. If you want more details, the SBA’s website is a great place to start.
- The SBA is not a direct lender (in most situations). They simply guarantee repayment to the bank in the event that you fail to repay the loan. Your lender funds the loan and typically services it, though sometimes they sell it.
- The SBA charges a “guarantee fee.” This is primarily how the SBA program is funded.
- The SBA guarantee doesn’t get you off the hook if you default on the loan. It reimburses the lender, but this doesn’t impact how much you owe. Borrower’s often get confused by this, so I’m going to say it again. The SBA guarantee is for the lender, not the borrower. If you take an SBA loan and default, the SBA guarantee does not relieve you of the obligation to repay the loan.
- SBA loans are great for borrowers who meet all the normal criteria for a traditional business loan except collateral. If you have good personal credit, two to three years of profitable operating history, strong experience in the field, and cash to inject, but not enough collateral to cover the loan, an SBA loan might be a good option for you.
- Startups with no operating history are unlikely to be approved unless it’s a franchise with a good track record. A business plan and a good idea are not enough to get you funding.
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What Happens If You Default on Your SBA Loan?
I’m not going to sugar coat it. If you can’t make your loan payments, bank levy, wage garnishment and foreclosures are all collection tools that are used with regularity. What exactly will happen to you will vary, as it depends on the details of your situation and your lender’s general attitude about settlements.
If you default on your loan and have pledged your home that contains equity, you risk foreclosure (in most states). That’s why you should think long and hard about pledging your home as collateral. Once it’s pledged, it can be awfully hard to get it released, even if your loan officer makes verbal assurances that the bank will release it after a few years of prompt repayment.
Even if you didn’t pledge your home, you’re still at risk of losing it because of that pesky personal guarantee. Since virtually every SBA loan I’ve seen requires the business owner to personally guarantee the loan, this particular point applies to almost everyone.
If you default on your SBA loan, the lender could sue you and attempt to levy your personal assets. Bank account levies and wage garnishment are most common, but I’ve had clients call me after the local sheriff’s office knocked on their door in an attempt to levy personal possessions (it’s not that common, but it’s jarring if it does happen).
Does the SBA Forgive Loans?
The answer, as with many nuanced things in life, is that it depends. The SBA doesn’t generally offer 100% forgiveness for 7a and 504 loans. It is, however, open to the possibility of settling for less than the full principal balance under certain circumstances. This process is known as the SBA Offer in Compromise (OIC).
The circumstances under which the SBA will consider loan forgiveness include the following:
- The business has ceased operations and the business assets have been liquidated. Selling your business as a going concern is okay too, as long as it’s an arm’s length transaction. This means you are actually selling the business to a buyer, with no “side deals” that allow you to buy the business back later.
- You demonstrate to the lender and the SBA’s satisfaction that you lack the resources to repay the loan in full over a reasonable period of time. This requires full disclosure and a fair amount of paperwork. You can find a comprehensive list here.
- The participating lender recommends approval of the OIC. The SBA requires the lender to screen OICs and make prudent lending decisions that protect the SBA’s money as it would protect its own. If lenders are found to have made decisions contrary to that requirement (such as releasing a lien on the property that contains equity without getting anything for it), it could result in what’s known as a guarantee repair or denial.
- Requests for debt forgiveness should bear a reasonable relationship to the amount recoverable through enforced collection. In plain English, this means that your offer should be similar to the amount the bank might expect to recover if it sued you and went after your assets and income. It should be noted that there is no single formula to determine the amount you should offer, as there are some subjective aspects to determining what constitutes an acceptable offer. Factors like age, health, future earning potential and borrower cooperativeness are just a few of the subjective elements the SBA considers.
While nobody goes into business expecting it all to fall apart, you can take solace in the fact that if you have to close your doors, the SBA is willing to work with you to reach a mutually beneficial resolution. They won’t let you walk away scot-free, but if you’re willing to come to the table and make a good faith offer, there’s a chance that the SBA will consider partial forgiveness of your debt.