SBA Loan Default: What Happens if You Default on an SBA Loan?

SBA Loan Default: What Happens if You Default on an SBA Loan?

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Defaulting on a Small Business Association (SBA) loan entails a different process than defaulting on a standard bank loan. Because an SBA loan is a federal loan, there are special procedures and methods in place that the government can use to collect on the unpaid debt.

What Your Bank Does During Default

If you default on your loan, your lender will be the first one to take action. As a first step, your bank will inform you, either through a phone call or letter, that your loan payment is past due. At this point, you should reach out to your lender to negotiate a loan modification or deferment rather than letting the loan go into default. If you don’t pay or reach an agreement with your lender, your lender has the right to start the collections process.

Because most SBA loans are secured by collateral and a personal guarantee, the bank will have the right to seize the business and personal assets you pledged. This means the bank may force you to close your business and liquidate assets to recoup their money. If you have a bank account at the same bank where you took out the loan, the bank generally has the right of offset, which allows them to withdraw funds from your accounts to cover past due payments. If you have bank accounts elsewhere, your bank can still get a judgment against you to garnish your accounts at other institutions.

If you pledged your home as collateral or as part of a guarantee, the bank also has a right to foreclose on this property. Whether they actually foreclose will depend on how much money they can recover during the process. The bank will typically need to pay off any primary lien on the property, like a mortgage or home equity loan, before they can foreclose. If you don’t have much equity in your home, your bank may decide it’s not worthwhile to pursue this method. However, if you have substantial equity built up in your home, or have paid off your mortgage, the bank may very well foreclose. Because of your personal guarantee on the loan, a bank may seize other personal assets in addition to your home. Depending on which state you live in, this could even include the seizure of retirement accounts.

When Does the SBA Get Involved in the Default?

If your bank has exhausted all avenues for recovering the debt but still has not recovered the full amount of the loan, they can make a claim to the Small Business Administration against the guarantee the administration put on the loan. At this point, the SBA will pay out the guarantee to your bank and take over the collections process. The SBA will send you a letter requesting that you either pay the full amount due or present an “offer in compromise” within 60 days. If you don’t respond to this letter, your debt will be sent to the U.S. Treasury Department for collections.

Offer in Compromise

An SBA offer in compromise (OIC) is a proposed settlement to pay a reduced amount of the debt owed. You will submit a proposal to settle the debt and provide evidence, which includes business and personal taxes as well as a complete list of your assets and debts, to back up this proposal. The offer you submit must be fair and reasonable, meaning that you need to be able to repay what you are proposing. In most cases, the SBA prefers a lump-sum payment offer over a payment plan.

You will submit the offer in compromise to your lender first. If your lender approves the offer, they will send it to the SBA for approval. In some cases, your lender may not entertain a settlement, either because they do not want to settle or they are unfamiliar with the OIC process. Whatever the case, both the lender and SBA must agree to the terms of the proposed settlement. If you’re rejected by the SBA, the administration may allow you to submit another offer, or they may send your debt to the U.S. Treasury Department for collection under the Treasury Offset Program.

If your debt is sent to the Treasury Department, you should be aware that they can collect using intrusive recovery methods, which include garnishing your wages, Social Security benefits or other retirement benefits, offsetting your bank accounts, and withholding any federal income tax refunds. Because this is federal debt, the Treasury does not need a judgment against you to collect money in this way, and there is no statute of limitations on how long they have to collect. While you can settle with the Treasury, it’s often difficult to do so, as the Treasury will most likely want to settle at a higher amount than the SBA. It can also be hard to find the appropriate contact at the Treasury with whom to begin the settlement process.

What You Can Do During Default

The best thing you can do is talk to your lender before you miss a payment. You may be able to negotiate a temporary deferment of your loan payments or a modification to your loan. If you miss a payment, it will be much harder to negotiate for these concessions. However, we still recommend you contact your lender to settle the debt before it’s sent to the federal government. For either concession, you’ll need to submit financial documentation to your lender and provide a compelling case for why you need to modify or defer your loan. The financial documentation may include tax returns, personal financial statements, a current balance sheet, accounts payable and receivable schedule, income statements and cash flow projections.

If you’ve already received the 60-day notice letter from the SBA, you should act quickly to put together an offer in compromise. The last thing you want is for your debt to be sent to the Treasury for collections. The offer in compromise you put together should address the debt owed and provide a reasonable plan that you can uphold. In some cases, it may be helpful to seek the advice of an attorney who specializes in debt settlement. They may be able to help you craft a good settlement offer that will have a better chance of being approved by your lender and the SBA.

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.