When your business takes out a loan, the plan is that you'll make all the payments in full. Things happen, though, and your business might face a situation where you're not able to make all the required payments. Missing a payment on a loan is known as defaulting. However, all is not lost if this happens. An agreement with your lender can result in a loan waiver, forgiving you for missing the payment as part of a restructuring, so that you can continue your business relationship.
When your business defaults on a loan, you may not know what to expect. Some lenders consider you to be in default if you're even a day late with your payment, while others may give you a 30-day grace period before default kicks in (check your loan agreement to get details on yours).
You can expect to receive a notice of default from your lender as soon as your loan reaches default status. If you can't make a payment, and if you don't contact the lender, your account may be sent to collections.
Consequences of loan default
What happens after you default on your business loan depends on what kind of loan you have.
If the loan is secured, the lender can seize the collateral (you may have used your home or your business's building as collateral, for example) and sell it to pay off the loan. If your loan is unsecured, the lender can sue your business for the amount due. If you personally guaranteed the loan, you can be sued individually as well.
Many loan agreements have clauses that allow the lender to charge more interest or accelerate the loan obligation (basically, make the entire loan due) when default occurs. If you have a bundle of loans with a lender, a default on one could trigger a default on others. All in all, defaulting on a loan can have negative consequences you want to avoid.
What to do if you're going to default
If you think your business is going to default on a loan, your initial reaction might be total denial or embarrassment, leading to frozen inaction. However, that's not your best choice.
Instead of hiding your head in the sand, the approach you should take is to immediately contact your lender and be up front about the situation. It's better to discuss your payment options before you default, if possible.
Getting a loan workout
You might be surprised to know that defaulting on a loan is not an uncommon situation. Many, many businesses face default and lenders encounter this situation regularly. It is by no means the end of your business.
Instead, you want to do what is called a loan workout with your lender. Basically, this means restructuring your debt so you can continue to work with them. Your lender may prepare a debt settlement agreement that will outline your new obligations moving forward. This will likely include new loan terms, including the interest rate, payment schedule, penalties, and collateral.
An important part of your loan workout will be a loan waiver agreement. This kind of agreement states that the lender waives their right to pursue the default on the loan. In exchange, the loan is renegotiated, usually with different terms, which allow you to continue to work together.
It's important to note that lenders are not going to do this out of the goodness of their hearts. Your business will need to provide current financial reports that will inspire confidence that you can repay the loan in the future. The terms of the new loan will likely be less optimal for you than your existing loan. You'll want to get legal assistance in creating a waiver of loan default, so that you can be sure you are signing a document that offers you the most protection possible.
Why lenders agree to loan waivers
It might seem a bit odd that, if you default on your loan, your lender would be willing to turn around and forgive your default and continue to lend you money. The incentive for your lender is that it's less expensive for the lender to do this than to sue your business and collect on the debt for the default.
A lender would much prefer to restructure your loan at a higher rate so that they can not only recover the full amount of the loan, but also earn more interest on your debt moving forward.
A loan default does not mean failure for your business. Instead, it's a crossroads where you need to restructure your debt for the future. A loan waiver can be a good solution for both your business and your lender.