What Happens If You Default on an SBA Loan?

“Loan default” are words that no small business owner ever wants to hear. Believe it or not, neither do lenders. Getting to the point of loan default usually means extenuating circumstances that might be uncontrollable. Lenders will also want to avoid this at all costs since it means they might also be at risk.

It’s important to understand what happens if you default on an SBA loan, as it is government-backed and often has stipulations associated with the loan agreement. That said, I’m going to walk you through everything I think you should know.

My two cents: Thoughts on SBA loan default based on my banking background.

My background in banking has spanned a few roles, and in each of them, I’ve had the privilege of working with a variety of small businesses. I understand just how important it is to keep a hand on the wheel that is your business finances and how scary it can be when it feels out of control.

The important things to keep in mind in regard to SBA loan default are to be proactive where you can, a good communicator where it counts the most, and open-minded when it comes to what to do next.

Lauren McKinley

Staff Writer - Finance at Fit Small Business

SBA loan default overview: What’s at stake?

SBA loan programs are one of the most popular forms of financing for small businesses since they can be used for various business purposes and offer favorable rates, long repayment terms, and a government guarantee. That said, sometimes, operational or economic shifts might have an impact on your ability to repay borrowed funds, and you might be unable to make payments and be in violation of your loan agreement.

If you’re wondering what this might mean for your business, let’s start with the basics.

What is SBA loan default?

When things take a turn and you’re no longer able to meet the terms outlined in your business loan agreement and make payments consistently, that’s where trouble starts. Missing a few payments might just mean you’re delinquent, but if that goes on too long without a fix? That’s when it shifts into default. And yes, that’s as serious as it sounds.

Not sure of the difference? Read my guide on delinquent loans, which discusses the differences between loan delinquency and loan default, to learn more and determine where you’re currently at.

Why it matters

Without resolution, the lender will likely seek to take action to recoup financial losses, as it likely believes you’re now in a position where it can’t reclaim funds. You’ll likely get notice from the lender before you get to this point, and there might be time in between delinquency and default in which you can try to remedy the situation and get back in good standing.

Most lenders will consider your loan in default if you haven’t made payments or worked out a resolution within three to four months. This is the window when you really need to be in close contact with your lender.

However, if you do end up in the “less than ideal” situation that is loan default, be prepared for legal repercussions. Those can include asset seizure, wage garnishments, or even personal assets.

How SBA loan default works, and what I think is most important

SBA loan default can be an awkward party to which, ultimately, nobody wants an invite. That said, you still need to show up and come prepared. In my time working with lenders, this can often mean having difficult but productive conversations about how to manage loans that might be taking a turn for the worse.

In my experience, here are the steps that are commonly associated with navigating loan default and how the situation may play out.

1. Work with your lender.

It’s important to note that while your loan may be associated with an SBA loan program, it’s the partnering lender who you’ll mainly be dealing with at first. They will be your point of contact in navigating the terms of your loan agreement and will help you determine what’s next.

They might be open to options like the following:

Loan deferment: Is a temporary pause in payments (often 3 to 6 months, sometimes up to 12); is helpful for short-term cash flow issues, though interest may still accrue.
Interest-only payments: Allows you to temporarily pay just the interest (depending on the lender), which can relieve pressure while your business stabilizes.
Loan modification: Usually means extending the loan term, which lowers your monthly payments over time.
Refinancing: Replaces your current loan with a new one that may come with better rates or terms.

The key takeaways here are to think of deferment or interest-only payments as a short-term fix, and modifications or refinancing as a longer-term strategy.

My advice: Communicate early, and maintain a good relationship with your lender. The more you stay on top of your finances, the better your chances of avoiding default.

2. Review the default details outlined in your loan agreement.

If you’ve gotten that dreaded notice that you’re in default, pull out your loan agreement and review default details. It’s important to understand exactly what the lender is allowed to do and what you’ll be expected to do in terms of next steps. You may be subjected to asset seizure, wage garnishment, or other legal penalties.

My advice: Know exactly what’s on the table. It’ll help you plan your next move and understand expectations so that you can play your cards right.

3. Understand default clauses.

According to the terms of your loan agreement, the lender has the right to seize the collateral associated with securing the loan. This will likely be its first course of action if you don’t offer any form of repayment.

If you used business assets like equipment, inventory, or property as collateral, those are now at risk. Also, if you or someone else, such as a business partner or an investor, signed a personal guarantee, those personal assets could be on the line too. The lender and the SBA can pursue repayment from any guarantor listed on the agreement.

My advice: Prepare for the lender to enact default clauses if you truly cannot repay the loan. While it’s not an ideal situation, consider how the loss of assets might impact you and your business in the short and long term.

4. The lender files for the SBA guarantee.

If the lender is still unable to recoup financial losses, it will turn to the SBA. Since SBA loan programs are government-backed, the lender can file a claim for the SBA guarantee and seek coverage for the outstanding debt.

My advice: Don’t get comfortable. This doesn’t mean you’re off the hook; there will still be an attempt to collect funds from all parties.

5. The SBA will take over and attempt to collect the funds.

The SBA will essentially take over the attempts to collect, and the lender will be repaid the guaranteed portion of the loan. That said, an attempt to collect funds from you will still be made. Usually, this will take the form of a 60-day demand letter from the SBA, which requires a response within 60 days.

If contact is not made, the account will then be handled by the US Department of the Treasury. During this timeframe, you can either pay up or attempt to submit a letter of compromise.

If the SBA is unable to recover the loan or secure a compromise, it may charge off the debt, which essentially acknowledges that it’s unlikely to be collected in full. This doesn’t mean the debt goes away, though. Once charged off, it’s typically passed to the Treasury, which has its own collection tools.

My advice: Don’t ignore the SBA. It’s not fun having your account transferred to the Treasury.

6. Submit an offer in compromise.

If you are willing to work with the SBA and have extenuating circumstances that prove financial hardship, you can consider submitting an offer in compromise. That’s basically you proposing to pay a smaller amount to settle the debt. That said, this can be based on a wide variety of factors and will require you to be open-minded to the SBA’s needs.

The SBA usually requires your business to be shut down and assets liquidated before it will accept an offer in compromise. It wants to see that you’ve made every effort to reduce the debt before negotiating. If you’re still operating, you’ll likely be expected to keep trying to repay in full. You’ll also need to provide detailed financial disclosures, such as your personal financial statement (SBA Form 770), tax returns, bank statements, and a breakdown of any remaining assets.

And here’s the catch: The SBA will compare your offer to what it thinks it could collect through legal enforcement. If it believes wage garnishment or seizing your bank account would yield more, it’ll reject the offer. So, you want your proposal to feel reasonable compared to that alternative.

My advice: Heads up — a compromise is not at all guaranteed. You’ll need to provide solid documentation and be considered eligible, and the SBA has to agree to new terms.

7. The US Department of the Treasury will come into play.

If your offer in compromise is denied or you ghost the process, your debt gets handed to the Treasury. This is when things can start to get real serious, and it has a couple of tools it can use to collect.

Treasury Offset Program: It can take money from your federal tax refund, Social Security, or payments you would normally receive as a federal contractor or vendor.
Administrative Wage Garnishment: Your employer could be legally required to send up to 15% of your disposable income straight to the Treasury.

Notably, there is no expiration period for either method. They can both remain in effect until the full balance is paid, including any interest and collection fees that apply.

Once your case reaches the Treasury, it becomes much harder to negotiate. Its settlements tend to be less flexible and often higher than what the SBA might’ve accepted. You’ll lose the chance to explain your unique situation, and it becomes more about hard numbers and policy.

My advice: This is likely where you’ll end up if you go AWOL. Believe me, you should make every attempt at repayment before getting to this point to avoid legal repercussions that could end up with you in a lawsuit.

Looking to prevent default? Here’s what I want you to do

Ultimately, you want to avoid any of the previous scenarios, as they may result in having to shut your business down. Knowing how hard you’ve worked, keeping your small business afloat is our top priority here, so let’s discuss what I think you should do and what preventative measures you can take if you think you might be headed toward default.

Reach out to your lender ASAP.

Steps to take: If you’ve missed a few payments, you’ll likely hear from the lender before it enacts anything other than a late fee for the first three or four months. Get in touch with your lender immediately to discuss potential options if you think you’ll continue falling behind. This might include a loan modification that restructures your payment schedule or a discussion of other workaround solutions.
The why: Even if you’ve missed just one or two payments, call your lender. Most won’t come down hard immediately, especially if you’re honest and proactive. There may be room to modify your loan or work out a plan.

Get in touch with a trusted legal professional.

Steps to take: Find an experienced legal professional who has a good understanding of SBA loans to represent you, understand the jargon of your loan agreement, and help navigate next steps.
The why: They can explain what your loan agreement really says, help you understand expectations, and guide you to avoid mistakes that could have unwanted consequences, such as lawsuits or asset loss.

Consider your alternative options.

Steps to take: Cut corners where you can. You should do everything you can to avoid default, including considering alternative financing arrangements. If it’s your payment that’s too high, consider whether you might be able to refinance or modify the loan.
The why: Rates or repayment terms might ease your payment obligations with a loan modification. If you’re juggling multiple debt obligations, consider whether having a singular payment might help reduce your interest rates and help simplify your budget with one of the best debt consolidation loans.

Something a little extra: If you think you can bounce back soon, some short-term funding options might help. Those could include bridge loans, invoice factoring, or accounts receivable financing, all of which are tools that can give you access to cash quickly, especially if you expect an uptick in revenue soon. Just be cautious. They often come with higher costs or shorter terms, so ensure the math works in your favor.

Perform a hard audit of your budget and expenses.

Steps to take: This is the time to go line by line through your expenses. Where can you trim fat? What’s draining cash unnecessarily? Thoroughly review and keep track of all potential items here.
The why: Use this audit to determine 1) why you can’t make payments; and 2) where there might be flexibility to cut back on spending or where there might be opportunities to improve cash flow. Knowing those things will help you in conversations with your lender and in finding your financial footing again.

Figure out what you can sell off.

Steps to take: If you have assets that you can sell off quickly, like equipment, inventory, or even outstanding invoices, consider whether it’s worth selling them and putting the funds toward repayment. And while it’s unideal, you might even consider selling all or part of your business to avoid further financial losses.
The why: This can be a quick way to access cash and boost overall cash flow without having to enter into further debt to make repayment.

Think forward and creatively about revenue.

Steps to take: You might need to get creative in terms of your business operations. Ask yourself: Can you offer a new product or service? Raise prices? Cut costs without hurting quality? Try to think a bit outside the box in terms of how you can manage your future operations.
The why: Essentially, now’s the time to hustle a little differently to boost cash flow to help keep up with payments.

All that said, in some cases, continuing operations just isn’t sustainable. I’ve seen situations where the right, although tough, move was to close the business.

While that decision is heartbreaking, it’s sometimes the only way to stop the financial bleeding and get you back on your feet. But here’s the important thing to keep in mind: Shutting down doesn’t automatically wipe out your loan. If you signed a personal guarantee (which most SBA loans require), you’re still responsible for repaying that debt.

Extra help: Check out these resources

I recommend working with both your lender and an SBA representative if you’re looking for further information. If you’re unsure where to start, the SBA also offers free or low-cost counseling services through local district offices and partner organizations like the following:

Those resources can help you understand your loan, explore your options, and even assist in prepping paperwork for things like offers in compromise.

If you’re curious about SBA default rates or other SBA loan program performance metrics, check out the SBA’s loan program performance reports.

Frequently asked questions (FAQs)

Consequences of a defaulted SBA loan can differ based on the loan program, the loan agreement, and the participating lender. You could lose assets, face wage garnishment, damage your credit, or even be sued, depending on the terms of your agreement.

Yes, defaulting on SBA loans can subject you to garnished wages by the SBA. This is known as “administrative wage garnishment,” in which the SBA can collect up to 15% of income to help satisfy your business’s outstanding debts.

Usually not, unless you qualify for and are approved for an offer in compromise.

While the overall process is similar, the SBA itself, not a partnering bank, is often your direct lender on disaster loans. If you default, the SBA may still seize any collateral and can escalate collections quickly. You may be able to work out a repayment plan directly with the SBA, but if you don’t respond, the case will likely be referred to the US Treasury for further collection.

My final thoughts

I know SBA loan default can feel overwhelming. But you’re not alone, and there are ways to get through it with the right knowledge and precautionary measures. Whether you’re on the edge or already dealing with it, the most important thing is to stay informed, act fast, and ask for help.

Don’t wait for things to get worse. Start having the hard and honest conversations now. You’ve got this.

I Defaulted on My SBA Loan: What Do I Do?

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