If you are concerned about defaulting on your U.S. Small Business Administration (SBA) loan, you’ve come to the right place. In this article, I’m going to walk you through five must-know facts that every SBA borrower in default needs to understand about SBA loans.
1. The SBA guarantee doesn’t pay off your loan.
I once had a perplexed borrower call me. He had missed a few payments on his loan, and the bank was dialing up the pressure. That part didn’t surprise the borrower. The part that surprised him was that the SBA guarantee wasn’t going to get him off the hook.
The borrower (incorrectly) assumed that the whole point of the SBA loan guarantee was to pay off the loan for the borrower if they ever default. This is not how the SBA guarantee works. The guarantee reimburses the lender for their share of the loan, but it does not relieve the borrower of their obligation to repay the loan.
So, if you find yourself struggling to make payments, and your business is teetering, don’t expect the SBA to get you off the hook. The situation will need to be addressed.
2. Now is not the time to hide.
I know it’s tempting, but avoiding the problem is not the answer here. In the pantheon of poor advice about handling a defaulted SBA loan, the worst I’ve heard was to ignore it. While it might be sound advice with other creditors, it’s not for SBA loans. While it may be true that a credit card company will settle for less, SBA loans are generally the opposite.
If you settle while the SBA is still involved, settlements for 20-50% are common. For all the shade we throw at government efficiency and efficacy, I actually have found the SBA to be consistently reasonable when it comes to settlement. I can’t say the same for the Treasury, which generally wants 70-85% of the loan balance in cash.
3. Settlements are possible (but not a right!).
When your business closes and you still owe a bunch of money, the SBA realizes that you can’t get blood from a stone. This is especially true when you owe several hundred thousand dollars, and you’ve lost your life’s savings trying to make the business work.
Settlements are not a right. The SBA will settle only when it makes sense to do so. It doesn’t settle for the sake of settling. If you can afford to repay the loan, expect to pay it.
Many factors play into whether a settlement offer will be accepted by the SBA. I’m not going to get into all of them, as that’s a much longer discussion that can be found here, but in general, the SBA expects your offer to bear a reasonable relationship to the amount it could expect to recover if it sued you and levied your assets.
In practical terms, the SBA is most interested in your cash savings, real estate that contains equity and income. There are certainly other assets it could go after, but those items are the low-hanging fruit when it comes to settlements.
4. Your home could be at risk.
The good news is that the SBA encourages lenders to work with borrowers to keep their homes. This means that foreclosing on your home is typically a last resort. I’ve found this to be true in practice. Most lenders are not hoping to kick you out on the street.
The bad news? If you can’t find a way to make any sort of payment (lump sum or installments) after you’ve pledged your home as collateral, the lender will have no choice but to foreclose in order to recover some (or all) of the money they loaned to you (assuming there is equity in the home).
Some borrowers are astonished that foreclosure could happen, but from where I sit, it’s something that every borrower should understand going in. While it’s true that you sign a blinding stack of paperwork at the closing, you are making some major commitments that demand your understanding and attention. This is particularly true if you pledge your home as collateral.
5. Your LLC, S-corp, C-corp, etc. doesn’t make you untouchable.
The whole idea of forming a legal entity to own your business is to protect you from certain liabilities. So many business owners are stunned to learn that these entities don’t protect them if the business fails with a monster loan balance still due.
Why? Because the SBA almost universally requires personal guarantees from business owners. It knows that if the business fails, the legal entity typically won’t have enough assets to cover the debt. This is specifically why the SBA requires the personal guarantee.
If you are reading this thinking that you didn’t sign a personal guarantee, think again. In my 10-plus years in this business, I’ve yet to see an SBA loan that didn’t require personal guarantees from the business owner. The SBA requires anyone who owns 20% or more of the business, but often will ask “key” people who are critical to business success, to guarantee regardless of their ownership stake (and yes, they’ve seen the 19% trick!).
While it’s never anyone’s intent to be the former owner of a defunct business, the reality is that it happens every day to business owners all over the country. If you find yourself in the unfortunate position of closing your business and defaulting on your SBA loan, keep the above tips in mind. As I tell my clients, when you are in a position like this, there are no good options. You are simply trying to choose the “best” bad option.