Small businesses are a vital part of the U.S. economy, accounting for nearly 44% of gross domestic product, 36% of private-sector receipts, and 97% of exporters according to a 2021 report from the Small Business Administration (SBA). This is why financial assistance is crucial to get these businesses off the ground and keep them operational.
SBA loans are one of the most common forms of funding that small business owners can receive. Federally-backed SBA loans present an alternative means to grow a business outside of traditional loans that can come with higher interest rates. Small business owners as the borrowers can obtain credit at reasonable terms and with a repayment plan that fits their needs. Lenders, meanwhile, can build out their loan portfolios, grow their customer clientele, and increase their SBA expertise to a Preferred Lenders level.
However, there is a heightened risk of defaulting on the loan as small businesses can have less collateral and business stability. SBA loans may come with a guarantee of up to 85%, but the primary responsibility of repayment lies with the small business owner themselves. Before applying for loans, you also need to understand the rights of the lender and government in case of SBA loan default.
- SBA loans are granted to small businesses to expand their operations via long- or short-term capital, asset purchases, or startup expenses.
- Small businesses receive loans from SBA partner lenders and the borrower is obligated to pay this lender back.
- SBA guarantees up to 85% based on different loan amounts, which the lender can ask for payout in the case of a defaulted loan.
- Defaulting on your SBA loan can have major consequences including affecting your ability to borrow and get a business line of credit in the future.
- Be proactive and communicate with your lender regularly if you feel you’ll be late on a loan payment.
How SBA Loan Guarantees Work
The SBA supports small businesses in their growth and expansion through several different resources, including funding via its loan programs. A business owner’s decision to apply for SBA loans is often based on business needs, stage of development, available collateral, and how they plan to use the funds. The different types of loans that small businesses can apply for include:
- 7(a) loans: This is the most common SBA loan program and is used for short or long-term working capital, asset purchases such as real estate, and refinancing
- 504 loans: This program provides up to $5 million for major fixed asset purchases toward business growth and job creation.
- Microloans: This program provides up to $50,000 for startup expenses.
You do not apply nor receive the funding from the SBA. Applications are submitted to lenders, including partnering lenders, community development organizations, and micro-lending institutions that follow eligibility guidelines. Ultimately, you are applying for a bank loan and are obligated to pay the bank back.
The Role of Lenders
SBA loan lenders work closely with the government agency to ensure small businesses get ample opportunity to receive loans for business growth. With loan programs like 7(a). lenders are distinguished by their familiarity with the SBA guaranty process and categorized in the following program levels:
- Non-delegated lenders: These lenders distribute a smaller number of SBA loans infrequently
- Certified Lenders Program (CLP): Lenders in this level are experienced, have met certain performance standards, and, in turn, receive expedited loan processing and services from the SBA.
- Preferred Lenders Program (PLP): This program level is used by the most experienced SBA lenders, who have full authority to process, close, service, and liquidate most SBA guaranteed loans without the agency’s review.
The SBA can make receiving a loan easier for small businesses by giving a guarantee to commercial lenders. This takes some of the risk off the commercial lender, which is more likely to deny a small business loan request because of lack of business credit, financial history, and assets.
In the loan process, the SBA guarantees specific percentages on different loan amounts. For example:
- For loans of $150,000 or less, the SBA has a maximum guarantee of up to 85%.
- For loans of $150,000 to $500,000, the maximum guarantee is up to 75%.
- The maximum SBA loan amount is $5MM, but the max guarantee is only up to $3.75MM.
The process is similar to that of obtaining a normal loan. You will apply directly through the bank or other lender. The lender must thoroughly review the borrower’s application and review repayment ability, business operations, equity levels, and credit history. The lender must then apply for an SBA guarantee once the initial review is approved. Depending on the lender’s program level, this process may take anywhere from 24 hours (PLP) to 10 days (non-delegated leaders).
You’re Still Expected To Pay Back Your SBA Loan
As mentioned, while the SBA guarantees the loan up to 85%, it is not the actual lender. That becomes important if you fail to repay your loan on time. Despite the guarantee, you are obligated to make timely payments to the lender throughout the repayment period, which could be anywhere from 10 years (for working capital, inventory, or equipment loans) to 25 years (for real estate).
Defaulting on your loan can have major consequences on your business and personal assets or credit. For one, your business credit report will show the default status of a loan, decreasing your business creditworthiness and ability to borrow or receive a line of credit in the future. Further, your personal credit score would be affected if you’re a sole proprietor or used your credit in the business loan application.
Adequate collateral is generally required as security on all SBA loans and can include business assets such as real estate, inventory, business bank accounts, and manufacturing or office equipment. However, if you default on an SBA loan, lenders can seize this collateral. Additionally, because the SBA typically requires you to sign a personal guarantee, lenders can also seize your personal property if your business can’t pay with its own assets.
What Happens When You Default?
You should ensure you know all parties involved in processing an SBA loan. The lender will be the one who flags you as defaulting on your loan and takes initial actions to collect your outstanding payments.
Here is an overview of the process:
- The lender marks your account as delinquent after you’ve missed payments and tries to get in touch to collect.
- Lender marks your account as in default after extreme lateness, understood as 90+ days of missed payments.
- The lender now has the authority to seize assets set as collateral for the loan, including business and personal assets.
- The lender submits the loss to SBA to payout the guarantee if the outstanding balance is not covered after liquidating assets.
- The SBA contacts you to repay the loan amount covered in its guarantee.
- The SBA sends you to U.S. Treasury collections if you don’t set up a repayment plan with the SBA.
- The U.S. Treasury collects on delinquent debt, using remaining personal assets to cover the loss.
- The U.S. Treasury may take further legal action against you, including suing you in a court of law.
Each lender will have a different procedure for liquidating collateral or using other measures to cover a loan’s outstanding balance. However, it’s common for lenders to report delinquency after 30 days and default if you’re unable to pay in a reasonable amount of time, usually after 90 days.
What To Do If You’re Struggling To Pay Your SBA Loan
Being proactive is the best measure you can take when repaying your business loans. Every business owner faces hardship, but that doesn’t mean you need to jeopardize your credit or assets.
The lender wants to be repaid and is willing to work with its borrowers. Communicate with your lender regularly and inform it if you feel you’ll be late on a loan payment. If you think financial difficulties will continue, reach out again to discuss options. These may include restructuring your loan over a longer repayment period or making interest payments only for a specific amount of time.
Even though the SBA may not be your lender, the agency does provide support for your loan repayments. Try reaching out for local assistance and speaking to an SBA counselor to help you review cash flow or cut back variable or fixed expenses to cover loan payments. A smart business eye may help you identify additional funds to keep you out of default.
Frequently Asked Questions (FAQs)
Will the SBA file a lawsuit if I default on my loan?
The SBA or lenders can decide to file a lawsuit if you default on your loan. This is especially true if your business or personal guarantees don’t cover the outstanding loan amount. A lawsuit can be utilized to make a legally binding plan for repayment in case the business owner appears unreliable or as having no creditworthiness.
How do I know if I have an SBA loan in default?
Your lender should communicate with you regularly as your loan becomes delinquent and you fall behind on payments. The lending institution should also continue reaching out as your loan transitions into default status.