Is Your SBA Loan in Default? Forgiveness Is Possible

What happens if you default on your SBA loan?

If you can’t make your loan payments, a few serious repercussions can occur. Bank levies, wage garnishment and foreclosures are common collection techniques. What exactly will happen to you depends on the details of your situation and your lender.  

If you default on your loan and have pledged your home that contains equity, you risk foreclosure (in most states). That’s why you should think long and hard about pledging your home. Once it’s offered, it can be awfully hard to get it released, even if your loan officer makes verbal assurances that the bank will release it after a few years of prompt repayment.

Even if you didn’t pledge your home, you still have that pesky personal guarantee. Most SBA loans require a personal guarantee from the business owner, so this particular point applies to almost everyone. 

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If you default on your SBA loan, the lender could sue you and attempt to levy your personal assets. Bank account levies and wage garnishment are most common, but defaults can go as far as law enforcement knocking at your door to levy personal possessions (not that common, but jarring if it happens).

Does the SBA forgive loans?

The SBA generally doesn’t offer 100 percent forgiveness on 7(a) and 504 loans, no matter how dire your finances are. However, for companies that have had to cease operations, the SBA will consider settlements that have been agreed to between a borrower and their loan issuer.

Offer in Compromise

While the SBA does not forgive loans, it does have a settlement program called SBA Offer in Compromise (OIC) for businesses that have ceased operating. The SBA’s Offer in Compromise program is a process for borrowers who can’t fully repay their loan after liquidation and agree to settle with their lender for less than the full outstanding balance.

To get accepted into the program, there are some basic parameters you’ll need to meet:

• Your business needs to have ceased operations, and all of the business’s assets need to be liquidated. It’s extremely rare for a business to remain open and operating to settle its SBA debt, and it typically happens through some sort of bankruptcy.
• All obligors (i.e., borrowers and guarantors) who are seeking forgiveness must submit full financial  disclosure. Some borrowers want to negotiate without that information, and it’s typically a nonstarter. The SBA isn’t willing to negotiate for the sake of negotiating.
• An OIC will be considered only if you can demonstrate your ability to repay the debt over a reasonable period. This is why full disclosure is required. The SBA wants to understand what resources are at your disposal, and it will compare what it sees as available to what you are offering through “enforced collection” (i.e., what it could get if it sues you). When those amounts are similar, your OIC is likely to get some consideration.

Borrowers who are accepted into the OIC program will have their loans closed, and no further efforts will be undertaken by the SBA to collect their loan amount.

There is one notable exception to all of this: loans that were provided as part of the Paycheck Protection Program. Those loans awarded via that program during the COVID-19 pandemic are forgivable.

What to know about dealing with SBA loans in default

Whether you’ve already applied for an SBA loan or are thinking about financial assistance, here are a few things to take into consideration about loans that go into default.

Be cooperative; the SBA doesn’t have to forgive your loan.

Being in default on your SBA loan is likely one of the more stressful things you’ll have to contend with in life, so the temptation to avoid dealing with it is understandable. It’s much easier to simply ignore those emails and phone calls. Just keep in mind that if you want to eventually settle, one requirement (per the SBA) is that the participating bank recommends the OIC for approval. So, if you act like a jerk or annoy them, you run the risk of the lender not supporting your OIC. It’s not hard to imagine a loan officer being on the fence about your settlement offer, then deciding to decline it because you were rude, aggressive or nonresponsive.

Loan forgiveness is not a right. The SBA doesn’t owe you anything. A settlement is based on financial hardship, which means you need to prove that you lack the assets and income to repay the debt in full. Sometimes people claim they can afford to repay it but don’t want to since the business is already gone. It’s an understandable way to feel about a business that you no longer own but still owe a ton of money on.

Even when their loan isn’t yet in default, people ask if there is a way to settle their SBA 7(a) loan without actually going into default. Lenders vary on this point. Some won’t give you the time of day unless you have already missed payments. Others are more practical and will entertain an SBA OIC once the business closes, regardless of the payment status (current versus defaulted).

The bottom line is that if you expect to settle your SBA loan through the OIC process, expect to give the bank or SBA full disclosure. It wants to fully evaluate your situation to determine if you can repay the loan in full and, if not, what amount would be reasonable to accept as a settlement.

Organizational standards vary between SBA offices and bank branches.

While you may qualify by these criteria, that doesn’t necessarily mean you’ll get the same deal at every single branch or office. The standards and accepted practices vary by region (which is frustrating, considering they all are bound by the same standard operating procedures). While this may seem subjective and unfair, it’s a reality, one that an inexperienced advisor won’t know much about.

Bypassing the lender rarely works.

When working directly with your SBA lender, sometimes you won’t get the answer you’re looking for. But when things don’t break your way, going over your lender’s head isn’t going to work unless they’ve done something egregious. Why? If your lender is servicing the loan, the SBA will defer to the lender in the vast majority of situations.

The SBA depends on (and compensates) its lending partners to service SBA loans, which includes making decisions on OICs. There are millions of SBA loans out there, so the SBA simply doesn’t have the manpower to get involved in every single loan.

It’s not an easy way out; it has costs.

An OIC is not a free pass. If you want to settle, you need to be prepared to give the SBA the pound of flesh it requires. Obviously, the biggest question every borrower has is how much the SBA will want. The exact amount depends on a lot of factors, so there is no blanket answer.

These are some factors the SBA considers:

• Is your home pledged, and is there equity?
• Do you have cash savings? (This is an easy one. If you have cash, the SBA will want at least a portion of it unless you have a valid reason why you can’t give it.)
• Do you own assets that could be sold to raise cash? Boats, RVs, extra cars (the SBA usually won’t ask you to sell your only car), collectibles, etc., are all possible sources of cash.
• Do you have a steady income (or a spouse with income, even if they didn’t guarantee the SBA loans)?
• What does your future earning potential look like? Age, profession, education and health are all factors here.

SBA loan forgiveness is a hard nut to crack, but it’s possible. Understanding what’s negotiable and what’s not is imperative to succeeding with the OIC process. It’s their game, their rules. If you want to settle, you don’t have the option to take your ball and go home, so make sure you understand all the nuances of the process, or find someone who does.

Jason Milleisen and Dock Treece contributed to this article.