Can an SBA Loan Be Forgiven?

Learn how SBA loan default and forgiveness works

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New or nascent small businesses typically have limited options when it comes to financing their budding enterprises. Most traditional lenders require applicants to pledge significant collateral or show strong business financial statements to be approved for loans. Luckily, the U.S. Small Business Administration (SBA) offers a suite of loan products geared towards startups and burgeoning small businesses. These loans are issued by third parties—such as banks or credit unions—and guaranteed by the SBA up to 85%, so the risk is significantly mitigated for the lender.

However, if, during the course of business, an SBA loan recipient becomes unable to pay its loan, the lender will make attempts to collect any pledged collateral. The lender will then turn the debt over to the SBA. The government has standards and practices to recoup lost funds, but it may be able to settle with the loan holder for a reduced amount. This process can be costly and time consuming for the business owner but can ultimately result in a form of loan forgiveness. 

We’ll discuss what happens when you default on a loan and how loan forgiveness works.

Key Takeaways

  • SBA loans are lower risk for third-party lenders since they are backed by the government by up to 85%.
  • Though SBA loans are aimed at helping small business owners succeed, if a business goes into default on its loan, there will still be a tedious collection process from both the third-party lender and the Treasury to recoup the lost loan funds.
  • After assets and collateral have been seized, wages garnished, and/or tax refunds withheld, the SBA will send an “offer in compromise” letter, which allows the business owner to suggest a settlement amount that they can afford to close out the loan.
  • Regardless of your business situation, it is always best to have a strong relationship with your lender and stay in proactive communication with them regarding your financials.
  • Depending on the loan and the lender, some interventions may prevent your loan from going into default.

How Do SBA Loans Work?

SBA loans are an ideal resource for small businesses that might not otherwise qualify for traditional loans. The SBA offers various loan products ranging from $500 to $5.5 million in funding, all with competitive rates, broad eligibility requirements, and reasonable terms. The federal government partners with third-party lenders, such as commercial banks or local credit unions. These lenders vet applicants, own the loan, and collect the interest.

The SBA sets the terms, conditions, and eligibility of each type of loan, and lenders must uphold those guidelines when evaluating applicants. Ultimately, these loans can be far less risky for the third-party lenders because the SBA guarantees a portion of the funds, usually somewhere between 50% and 85%.

What Happens When You Default on an SBA Loan?

There may come a time when a small business is unable to repay a loan issued by the SBA via a third-party lender. Perhaps you need to delay payment due to a cash flow issue, or maybe you’ve exhausted your resources and can no longer meet the payment terms. Regardless, once your business starts to miss its scheduled loan payments, you’ll become delinquent on your debt.

Each lender has different policies and procedures for collecting delinquent funds. Some may reach out to understand why you’re unable to pay and work with you to find a solution (i.e., partial payments, extending due date) to avoid default.

The Default Process

Some lenders will work with businesses for a few months to avoid sending a loan into default. But if a business continues to skip payments without an arrangement with the lender, then the latter usually has no choice but to send the loan into default. Defaulting on a loan is likely to have a very negative effect on your business’s credit, and often on your personal credit, as well.

Here is an outline of what happens if you default on an SBA loan:

  1. Your lender (not the government) attempts to collect any pledged collateral to repay as much of the loan as possible. This might include equipment, bank accounts, real estate, or inventory.
  2. If the loan was personally guaranteed by you or anyone else, the lender can call on any personal assets by garnishing wages or foreclosing on your home.
  3. If the collateral seized does not equal the full amount of the loan, the lender turns to the SBA to fulfill its guarantee on the amount of the loan, minus the value of the collateral.
  4. Once the lender has been repaid, the SBA attempts to collect the debt from both the business itself and from you as the owner. Federal law mandates that if a government agency is owed a debt, they must turn the delinquent debt over to the U.S. Treasury for collection.
  5. The Treasury can recoup the debt by drawing from tax refunds, withholding salary, and benefits of federal employees or by mandating employers to garnish wages.

How SBA Loan Forgiveness Works

Once a business has no more options for debt repayment, it may have to cease operations. At this point, any remaining collateral will be liquidated to pay back the SBA loan.

When it’s clear that there are no remaining assets to support loan repayment, the SBA will likely issue an “offer in compromise” to borrowers who cannot fully repay their loan.  An offer in compromise arrives via a form from the government and the business owner must propose a settlement amount within 60 days.

A business must have ceased operations and liquidated all other collateral to be considered for an offer in compromise. The offer amount should have a reasonable relationship to the amount of the debt owed and be paid in one lump sum.

To have an offer in compromise approved, the business will also have to use financial statements to prove that the loan is in liquidation and that the business cannot support the loan payments. Generally, this is done through business and personal tax returns, financial statements, and any corroborating evidence regarding business and personal assets.

While the SBA will not forgive 100% of the debt owed, the goal is to settle on a number that makes sense for both the agency’s bottom line and a business’s financial ability to pay. If the SBA approves the offer in compromise, a payment will be issued and the loan will be classified as “Compromised/Closed.”

How To Increase Your Chances of Loan Forgiveness

Small businesses commonly run into cash flow roadblocks that may make repaying a loan difficult. This is partially why the SBA loan program exists in the first place—to give otherwise relatively volatile loan candidates a fair shake at the necessary capital to grow and succeed. If a business simply can’t make its payments, however, the first thing its owner should do is be proactive with their lender.

Communication is key. Talking to your lender right away is always the best option when you are in danger of becoming delinquent. Some lenders may waive late penalties even after the designated grace period or restructure your payment plan to help you repay the loan.

Some banks and credit unions may be able to renegotiate loan terms, interest payments, or payment plans to ensure that you can avoid going into default.

Frequently Asked Questions (FAQs)

How do you apply for SBA loan forgiveness?

Partial forgiveness for an SBA loan can be issued only after a loan is in liquidation and a business has ceased operations. At that point, the SBA will issue an offer in compromise as a way to settle the loan, usually for less than what is owed.

How long does SBA have to review PPP loan forgiveness?

Under the SBA’s Interim Final Rule, the agency must issue a decision within 90 days after receiving a forgiveness application. If borrowers of Paycheck Protection Program (PPP) loans do not apply for forgiveness within 10 months after the last day of the covered period, then PPP loan payments are no longer deferred. Borrowers will then begin making loan payments to their PPP lender.

Article Sources

  1. U.S. Small Business Administration. "Loan Fact Sheet," Page 1. Accessed Jan. 4, 2022.

  2. Office of the Comptroller of the Currency. "Bankers’ Guide to the SBA 7(a) Loan Guaranty Program," Pages 6 and 10. Accessed Jan. 4, 2022.

  3. U.S. Small Business Administration, North Dakota District Office. “Collateral and Credit.” Accessed Jan. 4, 2022.

  4. Bureau of the Fiscal Service, Debt Management Services. “Debt Management Services: Code of Federal Regulations.” Accessed Jan. 4, 2022.

  5. U.S. Small Business Administration. "7(a) Loan Servicing and Liquidation," Page 122. Accessed Jan. 4, 2022.

  6. U.S. Small Business Administration. “Offer in Compromise Requirement Letter,” Page 1. Accessed Jan. 4, 2022.

  7. Credit Union National Association. “SBA Must Address Backlog of PPP Loan Forgiveness Applications.” Accessed Jan. 4, 2022.

  8. U.S. Small Business Administration. “Paycheck Protection Program Loan Forgiveness,” Page 1. Accessed Jan. 4, 2022.