What happens if I default on a business loan?

Understanding your options when you cannot repay a business loan

Defaulting on a business loan typically involves missing several payments or consistently paying late. Your lender’s definition of a default will be included in your loan agreement but, essentially, it’s considered a breach of contract.

If you receive a default notice, you need to take action quickly and pay the outstanding amount if possible. Lenders charge very high interest rates when a borrower defaults, which along with the charges applied, may seriously compromise your cash flow.

Defaulting on a loan can also damage your business’s credit rating and limit its future borrowing capacity. The exact consequences of defaulting, however, depend on whether the loan is secured or unsecured.

Secured and unsecured loan defaults

Defaulting on a secured business loan allows the lender to take possession of the asset(s) used as collateral. This might be a vehicle, for example, or a piece of equipment, but they have legal recourse to recover their money by selling the asset.

If you default on an unsecured business loan and don’t make up the payments quickly, the lender will begin their debt recovery process. This typically starts with reminder and warning notices followed by the default notice on missing a third payment.

What are the consequences for my business of defaulting on a loan?

High interest rates and charges

Lenders charge extremely high interest rates and apply hefty charges following a loan default. This can lead to a spiral of debt if cash flow is already poor.

Damaged credit rating

When deciding whether or not to sanction borrowing, lenders look at an applicant’s credit rating and history of repayment to evaluate their risk of losing money. If you default on a loan your credit score will drop and your business will be viewed as high risk. 

Limited borrowing capability

The default marker placed on your business’s credit file remains there for six years. During this time you’re likely to find it more difficult to obtain business borrowing, which can limit growth.

Personal guarantees and business loan defaults

If you’ve provided a personal guarantee for a loan, it makes you personally liable to repay the full outstanding balance and places your personal assets at risk. This is because the lender can pursue you through the courts to recover their money.

Personal guarantees are commonly demanded by lenders on unsecured loans, but in some instances, may also be required on secured loans when the financier needs to further limit their risk.

How to avoid defaulting on a business loan

Forecasting and closely monitoring cash flow is key to avoiding a loan default. Cash flow forecasting is an invaluable addition to your management accounting procedures that helps to keep your business financially stable, as you’ll be aware of any upcoming cash flow shortages and be able to source financing if needed. 

Choosing the right loan that doesn’t overstretch the business financially is also a primary part of avoiding default. UK Business Finance is an established commercial finance brokerage and can help you find the most suitable loans with the best rates.