Consequences of Defaulting on a Business Loan and How to Avoid Them
For a business to survive and expand, capital is a mandatory requirement. There are several ways for a business to raise funds and business loans are one of the most popular ways of doing so. They are useful in meeting urgent financial needs as well as to cater to projects that require heavy funding. Business loans help ventures to raise funds without having to give up on their equity.
As much as they are meant to help you, there can be several short-term and long-term consequences of defaulting on a business loan. Let us understand them in detail.
What Does a Business Loan Default Mean?
When a business fails to honour the repayment terms of its loan agreement whether deliberately or otherwise, it is known as default on your business loan. An unintentional loan default can be caused due to any unforeseen negative circumstance that disables a business from repaying its instalments on time.
Consequences of a Loan Default
Defaulting on a business loan can create a negative impact on your business. It not only hurts your credibility but also makes it harder for you to get new loans in the future. Such business houses are considered “bad risk” for lenders, and they may have to face the following consequences in case of a loan default:
- Reduced CIBIL Score: Credit agencies keep a strict watch on your repayment activities. Every failure in meeting your deadline brings your credit score further down. This not only gives you a bad credit score but also makes it hard for you to get approval for any new loans in the future.
- Higher Interest Rates: Poor credit score makes you ineligible for getting several types of loans. Even if you did manage to get a loan approved, it would likely be at a much higher interest rate.
- Creates a Bad Reputation for Prospective Investors: If you are looking for investors to invest in your business, a loan default might not be a very good start. It indicates that your business has not been holding up well and this puts you in a weak bargaining spot.
- Foreclosure of Assets: In case of default on a secured business loan, a lender has the right to sell the assets that you put as collateral. So if you failed to honour the terms of your secured business loan, you can end up losing your assets.
- Legal Suits: For unsecured business loans, even though the lender cannot claim any of your assets, they can still take legal measures to recover their money. This can eventually still lead to loss of your assets or garnishing of wages. In secured also legal measures will be taken by lender.
- Bankruptcy: In case the lender is not able to recover their entire sum with a legal suit, your business may be forced to file for bankruptcy.
If you are worried about facing such repercussions, worry no more. We have compiled for you several ways that you can follow to avoid having such inflictions on your business. Here is a detailed guide on how to avoid defaulting on your loan.
Ways of Preventing a Loan Default
Here are some ways you can prevent being a defaulter:
- Know Your Rights and Responsibilities in Advance: Before signing any papers for your loan agreement, make sure you understand the terms thoroughly. Try to negotiate the conditions to the best of your capabilities before finalising anything. This will give you more favourable loan conditions making the repayment easier.
- Maintain a Sufficient Bank Balance: Facing unforeseen business circumstances is not unheard of. To avoid facing any repercussions in such scenarios, make sure to create a reserve for your repayments in advance.
- Restructure Your Loan: When you make any modifications to the terms of your loan agreement such as a new interest rate or a new repayment schedule, it is called restructured your loan. This slightly affects your CIBIL score, but it is still better than defaulting on a loan entirely. If you find it hard to keep up with your existing loan agreement, reach out to your lender and talk about the options available to you.
Unforeseen fluctuations in the course of a business are inevitable, but defaulting on your business loans is never a good idea for that reason. This not only sends out a wrong message to the credit rating agencies but also to prospective stakeholders in the future.
If in case the default is deliberate, you can also end up facing legal actions not just against your business, but personally against you as well. To avoid that from happening, make sure to choose the type of loan and lender whose terms align with your business goals.
Frequently Asked Questions
What are the types of business loans that I can get?
There are several types of business loans available for ventures in India. Some of these loans include term loans, working capital loans, start-up loans, business overdrafts, loans for women, etc.
Can I go to jail for a business loan default in India?
A genuine business loan default is a civil offence and would not send you to jail. However, a lender has the right to sue you for your default. Resultantly, you can be summoned to the court and it is your obligation to appear before it in that case.
How does my CIBIL score affect loan eligibility for my business?
Your CIBIL score is a three-digit credit score that reflects your credit history. Business houses that have just started out cannot be expected to have a credit history or a high credit score. In situations like these, it is the credit score of the entrepreneur that is considered for loan approval.
In what circumstances will I be considered a wilful defaulter?
Any circumstance where you have the funds available for repayment of your loan but you choose not to for any reason makes you a wilful defaulter. It is a criminal offence in India and can lead you to jail.