As of April 2019, it’s easier than ever to get approved by a bank for a small business loan.
But, the ease of securing a loan doesn’t change the consequences you’ll incur if you default on one. It’s important to avoid these at all costs.
Not sure where to start? Don’t worry, we’ve got you covered.
Let’s take a look at everything you need to know about loan defaults and the complications they can cause.
Debt Service Default
When a borrower is unable to make the required monthly payments on a debt, it’s considered a debt service default.
Typically, a loan won’t reach this status after one missed payment. It’s up to the lender to decide when a borrower has defaulted on the loan or simply needs extra time to catch up on their missed payments.
If the borrower still doesn’t pay what they owe on the defaulted loan (often the principal plus interest paid in full), the lender can garnish their wages or even withhold their tax refund.
In certain cases, the lender can also seize funds from the borrower’s bank account in order to get their money back.
Strategic Default
As the name suggests, this scenario involves the borrower defaulting on the loan on purpose. Certain types of loans prevent the lender from pursuing the borrower’s assets if they fail to make the required payments.
Strategic default is occasionally an option people take when looking to get out of a mortgage.
For example, the housing market crash of 2008 left many people with mortgage payments that were far higher in total than what their homes were worth due to the sharp decline in home value.
So, rather than pay the rest of their mortgage off, many people simply walked away and let the lender repossess the home.
While a lender often can’t claim the borrower’s assets after a strategic default (that’s why it’s considered strategic, after all), the borrower’s credit scores and ability to secure future funding will greatly suffer as a result.
Technical Default
Interestingly, this type of default has nothing to do with making your monthly payments on time. Instead, it means you’ve violated the terms and conditions of your loan agreement.
Technical defaults occur most commonly when a business doesn’t adhere to the loan agreement with their lender.
For example, a lender may declare that the business can’t drastically change their branding, offer certain products, etc. until the loan is repaid in full.
Doing so will breach their agreement and put the borrower into technical default.
A technical default commonly results in the borrower having to repay the loan amount in full, which is often difficult once the money has been used to get a business up and running.
Avoiding Loan Defaults Can Seem Like a Difficult Task
With the proper planning, though, it won’t be.
The above information about loan defaults will help you avoid this situation and keep you in good standing with your lender.
If your credit isn’t great and you still need financing for your business, check out this article for tips on how to secure one.