Most of the time, Indian MSME owners often depend upon loans to manage cash flow, expand operations or deal with unexpected challenges. Among such types of loans, unsecured business loans are very popular because they don’t require collateral with a quick processing time. However, failing to pay back an unsecured business loan, or defaulting, can have severe issues.
Let us understand what happens when you default on such a loan and how you can avoid this situation.
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Consequences of Default on Business Loan
Defaulting on an unsecured business loan exposes businesses to several financial, legal, and reputational challenges. These are the key consequences described below:
1. Bad Credit Score: It gets reported to credit bureaus when you miss or fail to repay the loan. This will make you lose some points on your credit scores. Low credit scores put you in a position that makes it hard to achieve future loans or financial aid since lenders might think that you are a high-risk customer for them.
2. Legal action from lenders: Since unsecured loans do not carry any form of security, lenders can take them to the courts for recovery of their money. They can sue you in court as per your loan agreement terms.
3. Threats from Debt Collectors: Upon failure, debt collection agencies would get called to recover dues, where there would be much unwanted contact with the debtors from such agencies resulting in great stress and harassment.
4. Harshness toward the Business Credibility: Default of any loan adversely affects your credibility rating of the business because their suppliers or partners or even investors won’t like working for an unestablished financial state business or with a less credible person.
5. Higher Interest Rates in the Future: Even if you will be able to get a loan in the future, it would probably be more expensive because of your history of default. Lenders raise interest rates for borrowers with a poor repayment record to offset their risk in lending to these people.
6. Loss of Personal Guarantees: Most unsecured business loans require personal guarantees. In the event of a default, the lender will look into your personal assets, like savings and property, to recover any outstanding amount.
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Tips to Avoid Business Loan Default
Here are practical tips to guide you with effective management of loan repayments:
1. Prepare a Credible Repayment Plan: Before availing a loan, assess your business’s income and expenses. Select a loan amount and repayment tenure that suits your cash flow. A realistic plan ensures you can manage EMIs (Equated Monthly Installments) without financial strain.
2. Record Cash Flow Cycles: Monitor in the inflow and outflow of cash in your business. By so doing, you will identify financial gaps early enough and therefore take corrective measures. Monitoring in time ensures that you will set aside funds for loan repayment without delay.
3. Save for an Emergency Fund: Unforeseen expenses or a drop in income can affect your loan repayment schedule. An emergency fund helps you service your loans even when times are tough.
4. Communicate with Your Lender: If you expect trouble in paying back, inform your lender immediately. Most lenders will rearrange the loan for you by either increasing the tenure or reducing the EMI to make it easier to pay back.
5. Avoid Over-Borrowing: Borrow the loan amount only as much as your business requires and can pay back. Over-borrowing increases the chances of default because your repayment obligations might be higher than your income.
6. Cut Unnecessary Expenses: Review your business expenses and remove unnecessary costs. These savings can be redirected towards the loan repayments and you will be back on track.
7. Refinance: If the loan terms that you have are hard to deal with, you should consider refinancing. It is taking a new loan that has better terms to pay off the existing one. Refinancing can lower the interest rate and make the repayments more manageable.
8. Professional Advice: If you’re struggling with loan management, consult a financial advisor or accountant. They can provide valuable insights and strategies to improve your financial situation.
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Conclusion
Proper planning, monitoring and communication will see to it that one doesn’t become a victim of defaulting the unsecured business loans. One should borrow the amount responsibly and also ensure the repayment obligations remain in step with the capability of the business. Therefore, by following these processes, one will be capable of establishing a sound financial future for one’s business and having a healthy relationship with the lenders.
NBFCs lend unsecured business loans to SMEs and are very much in demand because these have flexible terms, quicker approval processes, and customized solutions that best meet MSME entrepreneurs which tempts MSME owners to apply for business loans from them. However, before availing of the above facilities, it is extremely important to read the terms and conditions provided by the NBFC and keep an account of timely repayments to further not complicate things. NBFCs have been a driving force behind financial inclusion.
