So, what happens when you default on unsecured business loans in India? If you’re reading this article, I believe you are an entrepreneur or planning to be one in the near future.
Are you planning to take a business loan to expand? Or, is it about the business capital that you haven’t started your venture yet?
Well, at one point or other in life, every entrepreneur considers taking or has already taken a loan to start or expand their business. Needless to say, they do have the best intention to pay off that loan.
Nevertheless, unfavorable situations like a sudden decline in the sales graph, a series of miscalculations or any other similar circumstance often results in unpaid monthly installments in time.
Multiple such instances cause small business owners to default on their business loans.
What is Loan Default?
To keep it simple and easy to understand, loan default happens when a borrower willingly or unwillingly breaches one or more terms of the loan agreement. This usually happens when a borrower fails to pay one or more installments in time as agreed during the loan tenure.
In such a case, the lender is eligible to take legal action (as per the loan terms) against the borrower.
What Happens on Defaulting a Business Loan?
Since there have to be some repercussions subject to loan default, these often vary based on how the terms and conditions of the loan were arranged and agreed upon. Loan default also affects the credit score of the borrower.
The following is a list of potential business loan default consequences in India:
Significant Fall in Credit Score
Every bank and financial institution reports all their monetary transactions to CIBIL and/or some other credit agencies. Therefore, each time a borrower misses an installment, the same is reported to the respective credit agency, which leads to a drop in the borrower’s credit score.
Also Read: 7 Simple Tips to Improve your Credit Score
Multiple such instances can significantly drop the credit score, which is known to jeopardize the chances of getting loan approval in the future.
High Rate of Interest on Loans
The moment the credit score starts dropping, the chances of further loan approvals start diminishing. In a case of loan approval, the rate of interest to be paid on goes sky high. In case the borrower also misses one or more installments of this very loan, the potential repercussions may be very unpleasant.
Potential Legal Action
In case a borrower defaults on a business loan, the potential repercussions vary subject to whether it was a secured or unsecured business loan. If it was a secured loan, the lender is authorized (as per foreclosure) to take charge of everything (asset and property) mentioned as collateral. The lender, in such a case, organizes a public or private auction to recover the loss.
On the other hand, the moneylender (bank or a financial institution) typically levies late fee charges if it was an unsecured business loan. However, some moneylenders pre-consider default on unsecured business loans and therefore ask for a personal guarantee or business asset. Such a lender can file a legal lawsuit against the borrower’s business.
Increased Difficulty for Loan Approval in Future
As mentioned above, defaulting a business loan (or any loan for that matter) decreases the chances of a loan in the future, as this act adversely affects the credit score. Consequently, the only option left would be financial institutions that levy high rates on interest.
The moment your moneylender realizes that you’re no longer interested in repaying your loan, the legal proceedings start in order to recover the loan amount. The collateral will be seized automatically, in case of a secured loan.
Also Read: How to Avoid Small Business Bankruptcy?
On the other hand, the moneylender reserves every right to sue you on loan default. The lender will recover the money as per the court order. In case the lender fails to recover the amount, the borrower must file for business bankruptcy.
Maintain sufficient Bank Balance
Maintaining sufficient bank balance is a good practice, it helps avoid missing loan EMI payment. Since businesses are always at certain volatile market conditions, ensuring some headroom is always advisable, no matter what. Try to maintain bank balance for up to 3 months’ EMI payment.
Always Remember the Dates
While remembering the dates is a good habit, there are times when people forget critical dates and then face trouble. It’s recommended to note down critical dates and set reminders for these. Doing this will help ensure sufficient bank balance for EMI payments.
A prior reminder certainly allows some time to add the required amount into the particular bank account to avoid missing EMI payment. Missing one installment won’t make you a defaulter, though. It will certainly lead to an applicable late fee.
Refinance the Debt
Taking a short-term loan while running a business tends to kill the overall momentum of potential growth. Needless to say, this is quite a common issue that many entrepreneurs face. Today, there are so many moneylenders that can refinance a business loan. These NBFCs provide long-term repayment options with smaller installments.
Nevertheless, this option is not a solution but only a precautionary measure.
Never underestimate the power of effective communication with the right intent. Let’s get to the point. No matter how much loan amount is yet to be paid off, staying in touch with the moneylender is always a good practice.
It’s recommended to communicate the problem (if any) that may lead to a payment delay or failure to the lender before the due date. There is no benefit in just sitting around and waiting for defaulting on the loan.
There are chances that the lender may increase the payment term or even reduce the monthly installment amount.
Prioritize Debt over Expenses
While this seems like simple advice that anyone can give, it turns out to be the building block of any business because it involves efficient financial planning and execution. When the business is new, make sure to have only the necessary expenses and prioritize debt payment.
As long as the loan repayment tenure is going on, there is definitely no escape from the monthly EMIs. This also means that every other expense is secondary. Besides, borrow the exact amount that you need, as a business loan incurs EMIs and interests. Otherwise, this will increase the debt liability to the business.
Seek Legal Assistance
In case a strong push is expected and there seems to be no escaping from defaulting on the ongoing business loan, it’s better to seek legal assistance and every piece of advice necessary to avoid the potential repercussions. Also, try to know what rights and provisions can help in current and upcoming situations.
The best way to effectively manage a business loan (or any debt for that matter), always ensure not to miss even a single EMI. In case there seems to be no way to avoid loan default, don’t just sit around and leave no stones unturned. Escaping was never an option; neither will it be in the future.
FAQs on Business Loan Default
Que 1. What is Personal Guarantee in my Business Loan Application?
Ans. When you apply for an unsecured business loan, the term personal guarantee refers to an undertaking from you (the borrower) to the lender that states you will make the EMI payments on time.
Que 2. Can I get a business loan if I have a guarantor?
Ans. While it is fairly difficult to get a business loan without any collateral or asset, certain banks allow borrowing up to 100% of the loan amount if you do have a guarantor.