After calculating the cost to start a business, you’ve finally got the funding. The SBA backed your idea and solid business plan to get you a bank loan. Your dream of having your own company is finally coming true. But what happens when loan bills outweigh the business revenue? If you’ve gotten behind and default on your SBA loan forgiveness could be an option.
How SBA Loans Work
The Small Business Administration helps entrepreneurs at all levels. Their programs make qualifying for business financing possible through partnering banks. Without the SBA’s loan guaranty, many of these businesses would otherwise not qualify. The guaranty limits lender risk by promising to pay up to 75 percent of the loan if the borrowing business happens to default.
The SBA also has their methods of limiting risk of default. Application criteria to qualify for their programs helps narrow candidates to those who are a good fit. Like Chase has the 5-24 Rule, the SBA may have certain stipulations depending on the type of loan. Some programs may only allow the loan proceeds to cover specific business expenses.
The SBA may specify the term of the loan. Borrowers may also have to sign a personal guarantee. Even with the best filtering process and quality candidates, default can still happen. By being a federal organization, the SBA can take extra measures to handle delinquent loans.
Who Handles Loan Forgiveness, the SBA or Partnering Banks?
The short answer is the SBA decides if loan forgiveness is an option. When you default on an SBA loan, both the bank and Small Business Administration have some involvement. The bank actually issues funds when the loan is approved, so they are the ones who will attempt to collect on a default loan. Once they have done all they can to get their money back, the SBA steps in.
SBA Loan Forgiveness Explained
As promised by the SBA, they will buy back the 50-75 percent of the loan they guaranteed. At that point, they will take measures to collect the money back from the borrower. The forgiveness comes in with the settlement agreement. After they pay the bank, you have an option to make arrangements to repay the SBA as much as you can. The administration forgives the remaining balance.
With the payment arrangement, you have an opportunity to propose a reasonable amount that you can afford. The SBA has the right to accept or reject your proposal. For the best chances of them accepting it, the amount you request to pay should be sufficient to pay back the loan in a timely manner. They also don’t want you to overextend yourself and miss payments again.
If you still can’t or refuse to pay back the loan with the SBA involved, they will begin other collection action. This action could include seizing assets from the company’s personal guarantor. To start, they will submit the account to the US Treasury Department.
SBA Loan Debt Collection Through the US Treasury Department
According to the US Treasury Department, they use two debt collection strategies.
1. Treasury Offset Program (TOP)
If you have a delinquent federal loan and expect an income tax refund, the funds will go toward clearing your debt. The Treasury Department compares names and TINs of outstanding loan holders to those receiving federal tax refunds. If the name in the Fiscal Service database are the same, the refund goes to reduce the loan balance instead of back to the taxpayer.
2. Cross-servicing
The SBA and other federal agencies send delinquent loans to “Fiscal Service”. The department could take several actions to collect the debt, including:
- Hiring private debt collectors
- Making payment arrangements
- Sending collection letters to the debtor
- Forwarding information to credit reporting agencies
- garnishing wages
- Withholding income tax returns
- Escalating debt to the Department of Justice
Benefits of SBA Loan Forgiveness
Even though it may be a difficult time, working out a plan with the SBA can be beneficial. For one, it could save your personal assets like homes, cars, and savings. The SBA requires a business officer to sign a personal guaranty. Putting forth effort to make good on the loan will prevent seizure of personal property and put toward the outstanding balance.
It can also prevent Chapter 7 or Chapter 11 bankruptcy, which can take years to recover from. Loan forgiveness prevents bankruptcy from becoming part of a borrower’s credit file. Without that derogatory information, borrowers will have a better chance of recovering and establishing credit again.
Consequences Borrowers Face for Having SBA Loans Forgiven
Though SBA loan forgiveness reduces business debt, it doesn’t leave the company free and clear. There are a few challenges to prepare for if experiencing loan default.
Businesses can no longer operate in order to qualify for loan forgiveness. That means they must close their doors and dissolve the business. They must liquidate all business property and use the proceeds to reduce their delinquent debt. If the owner has collateral attached to the loan like with beauty salon equipment financing, the lender will take possession of the property. They will sell it to recoup some of the money from the loan’s remaining balance.
Leaving outstanding loan balances will have a negative impact on credit also. Companies begin building business credit through bureaus like Dun and Bradstreet and Equifax Business. Lenders will report positive and negative business credit history, which helps determine business credit scores. Thus, SBA loan forgives can hurt personal or business credit.
Loan forgiveness affects possibilities of getting business loans, especially on the federal level. Personal lending ability can change too if you’ve signed as guarantor on the business loan.
If you’re considering an SBA loan, knowing the pros and cons upfront will help you make the best decision. You can’t predict the future of business, but you can prepare for whatever life throws at you. Before deciding on business funding, think about all the options. Unsecured alternatives like stated income business loans won’t affect your personal assets if business doesn’t survive.
