Business Loan Guidance

What Happens to A Business Loan If The Business Fails?

Every business goes through ups and downs before it becomes an established business. Every business, whatever its size and age, will face both profit and loss at some point in its journey. Such profits and losses have a profound impact on a business when it is in its initial stages. Small gains are enough to encourage a small business owner to work harder whereas a loss can be frustrating and bring disappointment. The disappointment can be even greater if the business that suffered the loss was under a business loan and had to default on the business loan.

Business loans are very useful tools for setting up and running a business smoothly. They help business owners by providing financial support when they need it the most. Knowing the fact that, both profit and loss are part of business, one should be aware of the consequences that can happen for business loans when the business faces a loss.

Definition of loan default:

In simple words, a loan default occurs when a borrower breaches a certain term of the loan agreement. Generally, this happens when a borrower does not make the agreed installment payments. This results in the lender taking legal action against the borrower.

Effects of defaulting on an unsecured business loan in India

Every entrepreneur, at one point or another, has considered taking or has taken out a business loan. Everyone has the best intention of paying off debt. However, due to situations like a sudden drop in sales, wrong calculations, or other unforeseen circumstances, your financial position gets affected, and you might not be able to make your monthly installments on time. Because of this, you might default on your business loan.

The effects of defaulting on a Business Loan vary according to the terms and conditions of the trade agreement. They can also affect your credit score. Below is a list of the consequences of defaulting on your business loan.

  • Credit scores drop

    Every time you miss an installment, the lender reports you to the credit agencies. This leads to a drop in your credit score, which increases your chances of getting approved for any loan in the future.
     
  • Increased interest rate

    Once your credit score drops, your interest rates will go up, or you'll be charged an additional late fee, depending on your business loan agreement. This may affect your current loan repayment and possibly your future loan approvals.
     
  • Legal Action or Foreclosure

    In case of a business loan default, depending on the loan type you have applied whether secured or unsecured loan, the consequences vary. In a secured loan, a foreclosure will allow the lender full possession of all your assets mentioned in your loan agreement as collateral. Typically, they sell the collateral at a private or public auction to recover their losses.

    In the case of an unsecured loan, the lender usually charges you a late fee. However, even in the case of unsecured loans, the lender requires a personal guarantee for your business assets. Therefore, on further failure, the lender can also file a lawsuit against your business.
     
  • Difficulty in getting a loan sanctioned in future

    Once you default on a loan with a bad credit score, it is extremely difficult to get any loan in the future. You will need to look for alternative ways to fund your business.
     
  • Declaration of bankruptcy

    If you default on your loan, the lender will initiate legal proceedings to recover the loan amount. In the case of a secured loan, the collateral may be seized. For unsecured loans, as discussed earlier, the lender will sue you for defaulting on the loan. The loan will be recovered as per the order of the court. However, if the lender is still not able to recover the loan amount, your business may have to file for bankruptcy.

    As a result, defaulting on your business loan has various adverse long-term and short-term effects.

If you are finding it difficult to repay your loan, there are many options available. Below are some pointers that will prevent you from defaulting on your business loan.

  • Maintain Adequate Balance

    It’s always good to maintain a sufficient balance in your bank account to avoid missing loan payments. A business is always subjected to volatile market conditions. Hence, it is advisable to give yourself some headroom. Keep a reserve in your account for at least 3 months of repayment.
     
  • Be aware of your due dates

    Always know the due dates of your installments. This ensures that you have the required amount in your account. Also, it helps you plan your finances better in terms of other expenses incurred in your business or other loans. Although if you miss an EMI, immediately it will not make you a defaulter. However, this may result in a late penalty.
     
  • Communicate with your lender

    If you think it will be difficult to pay the installments in the next few months, talk to your lender. It is unwise to just sit around and risk defaulting on your loan. Your lender may appreciate your proactiveness in managing your business loan and help you by lowering your monthly payment or extending your term.
     
  • Reschedule Your Loan

    If there is an issue with the amount of your company's outgo, you can always reschedule your finances. Your lender will revise your interest rates, and the loan term will be extended. This means that the monthly installment amount will come down and things will become more manageable. However, it will still hurt your credit score, but it is better than defaulting on your loan.
     
  • Manage Expenses and Prioritize your Debt

    This may sound like simple advice but is the building block of efficient financial planning. In the early years of your business, make sure there are only essential expenses. Paying off debt should be your priority. There is no exemption from monthly payments so, make sure that all your other expenses are secondary to it. Also, only borrow what you need.

Conclusion

Credit for a business can mainly come from two sources: first in the form of a business loan from a bank and secondly credit from investors through crowdfunding, angel funding, etc. If you default on a loan that is coming from an investor, you can go for negotiation to extend the time for repayment. One can use the extended time to settle the debt.

In case of a default, the borrower is subject to the rules of a professional lender and will have to handle the situation accordingly. However, the borrower can take some measures to minimize the adverse effects of defaulting on a loan by being pro-active. At the initial stage, if you are not paying your EMIs for a few consecutive months, the lender may anticipate that your loan may become a non-performing asset and hence the lender might start taking steps to ensure that the loan repayment takes place regularly. If the initial steps don’t work, they will eventually start the recovery process.

So, when it comes to debt management, always make sure you are regular with your payments. If you still feel that you are going to default on your loan, doing nothing is not an option. You must initiate a dialogue with the lender to appraise the lender of your situation and discuss the way ahead.

Poonawalla Fincorp is your one-stop solution for all types of loans. You can easily apply for our online business loan on the go.

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