There are countless reasons why SME owners would apply for a business loan in Singapore. It may be because you want to take advantage of a business opportunity that rarely comes by and you have to grab that chance. You may also need emergency funds to bail you out of a potential cash flow problem. It’s also possible that your business plans dictate that you have to upgrade your systems now before you’re taken over by competitors or technology disruption.
You get a loan. What now?
Don’t rest on your laurels, now that you have a done deal. It’s not the end of the challenge. In fact, you are facing another hurdle – paying back that loan. You may have gotten a term loan thus; your loan installments are comfortably spread over a few years. Smaller installment amounts are of course easier to pay. Still, you are indebted and you must diligently pay both the principal and the interest up until the end of the term. Unlike equity financing, debt financing means the business owner have to bear liability on the funding.
As somebody who’s been in business for a good length of time, you know that running an enterprise, is like sailing the seas. Sometimes you get into a storm and you have to be prepared for a rough ride at sea. You must have the skill and the presence of mind to weather it, keep your ship afloat, and make sure you sail smoothly.
Managing a business is pretty much the same. There are every day “storms” that could pose a challenge. For instance, when a major customer fails to pay you on time, it disrupts the timing of cash inflow to your business. Significant increases in import taxes on materials you use for a major product affect your costs. Sales can be affected by a bigger competitor who’s locating across your establishment.
Missing a payment and penalties
The everyday “storms” could affect your otherwise, healthy cash flow position and could lead you to miss some monthly payments. Even a few missed payments could result in penalty charges. Late payment penalty is often a related business loan fee and charge that most SME owners omit to look out for.
Different banks and financial institutions have different ways to classify a loan default event. Your loan contract specifies which conditions or acts constitute a default. While different creditors may have slightly different takes on when to declare a borrower in default (at the first instance or, after a series of nonpayment), what is certain is that they all charge penalties for nonpayment.
In general, most banks would classify a borrower whom is behind payment by 90 days or more as a serious event of default.
What creditors do when you’re in default
Your creditor will send you a notice once you are in default (based on the provisions of the loan contract). But, if you are already aware of the impending default, don’t wait for a notice. Instead, call your loan officer and tell him about the situation in advance. He will appreciate your transparency and might allow you some concessions depending on the circumstances. However, don’t expect too much, instead, do your best to settle the missed payments the soonest and avoid similar late payments in the future.
In case you’ve been missing a series of payments already, your financier will most likely continue sending you a series of legal notices. The first notice will likely be a short reminder that you were remiss on your payments and urging you to settle your past due amortization including late payment charges. The second notice will most likely be the same but with a firm directive to settle your obligations, and probably a reminder about the consequences of default. The next notice may already indicate possible legal action against you if you still fail to remit payments.
When’s the right time to discuss the problem?
Talk to your loan officer right away. Don’t wait for these notices to come to you. Don’t let late payment charges to accumulate. Addressing a problem while it’s still a mole hill shows you are a responsible and proactive borrower.
Discuss your problems with your loan officer. He’ll discuss with you a plan of action which could bring your loan account back to “current” status. Options may include restructuring of your loan but be prepared to pay a significant portion of your past due obligation before he could recommend any restructuring and account re-computation. If you do, he’ll have a greater chance of convincing approving authorities that you are serious about settling your past dues.
Defaults put a dent on your credit rating
The repercussion of default isn’t only about the burden of having to pay for penalties. It also hurts your personal credit rating. There are agencies which maintain and publish info about borrower’s credit profile, particularly his ability to pay and incidences of loan default. They assign a rating for each debtor and this is part of the service they offer.
Once you default, it will impact on your rating and this will further impact on your chances of getting a loan in the future. While you may still get approved for a loan, the terms may not be as good as those with another debtor whose credit rating isn’t marred by defaults.
Charge offs and problem accounts
When your creditor agrees to restructure your loan, he gives you a chance to make a rebound. If you are still unable to service your loan despite the loan restructuring, the bank might have to initiate legal proceedings to recover the dues.
If you haven’t paid your dues for a couple of months since restructuring, expect your lender to classify your account as “charge off”. Some lenders count up to six months of consistent non-payment before doing so. The term charge off is used normally for credit card debts which can no longer be recovered. For loans or credit lines, lenders usually refer to these as problem accounts.
If you have reached this point, expect your creditor to initiate legal action available under the loan agreement. Lenders won’t waste time. The will forthwith exercise their right to recover a loan which has gone bad.
Lender’s rights in the event of default
One of the lender’s options, in this case, is to foreclose on the asset you have mortgaged or assigned as security for the loan. So if your loan is secured by real estate property, machinery/equipment, accounts receivable, or a bank account, expect your lender to recover the default amount (including interest and penalties) through these mortgaged assets which is common in asset based lending.
The security documents as well as the loan contract you signed bear the provisions about what’s to be done in the event of a default and foreclosure.
For example, if your loan is secured by a real estate mortgage on a land you own, the lender has the right to foreclose on this property. Eventually, the lender will sell the property to recover the balance you owed and had failed to settle. Excess cash from the sale goes to the borrower provided there are no other liens on the property.
What happens if the loan you obtained is unsecured? Lenders, in this case, will proceed with the collection process. They may even hire collection agencies to do the collection proceedings on their behalf. In addition, unsecured loans are typically backed by your personal guarantee. Your business loan may be unsecured but do remember that banks cover their backs; hence they usually require a personal guarantee at the onset.
What’s the impact of a personal guarantee on a business loan?
A personal guarantee doesn’t create a lien on a specific asset owned by the business. Instead, it allows the creditor to take over any of your personal assets. The creditor will claim every asset you own until he has fully recovered the balance you owed.
Generally, there are two types of personal guarantee. If you opted for an unlimited personal guarantee in favor of your lender, the lender may fully recover the debt in question including related costs by taking over the assets you own. Therefore, the creditor can run after your retirement fund, your car, home, even your children’s educational fund until the balance (and related costs) is settled.
On the other hand, a limited personal guarantee suggests that the lender can run after your assets up to the amount you have both agreed upon in the guarantee documents. There is a ceiling or a cap on a number of assets the borrower can claim. Most banks will require the key directors or major shareholders to furnish personal guarantee with the liability capped at the amount of unsecured business loan extended.
There are some assets such as CPF balances and HDB flat that banks are not able to foreclose even with personal guarantees.
If the guarantors are not able to furnish any personal assets that can offset the outstanding business loans outstanding, the banks might in the worst case scenario proceed with bankruptcy proceedings against the guarantors.
Joint and several guarantees?
If you have other partners in the business, all other partners will usually have to furnish their personal guarantees for unsecured business loans.
In the event if there’s more than one guarantor to a business loan, the joint and several guarantee executed by all guarantors will bind all legally liable for the outstanding business loan in the event of company default.
Some business owners misunderstand that if there are 2 directors in a company and both furnished their personal guarantees to a company loan, the liability of the loan is shared equally between both guarantors. This is not the case as your business partner could affect your financing as well as extent of liability.
In a joint and several guarantee agreement, the bank reserves the legal right to claim against any one of the guarantor for the full amount of the loan outstanding in the event of company’s default.
How to avoid getting into a loan default
Don’t bite more than you can chew. Run through the figures again to make sure you don’t accept a much bigger loan then what you require, especially when you’re applying for multiple banks loans concurrently.
Prioritize payment of your debts. Put off unnecessary purchases for your business. Your debts should come first and your goal is to promptly settle all loan payments due to protect your credit grading.
Call your creditor right away if you foresee you’ll be missing payments in a month or two. By doing so, he may work out an extension and this will save you penalties which could disrupt your cash flow.
Make sure to compare all your loan options to ensure you’re not overpaying on interest and fees. Most SME owners bank with 1 of the 3 local banks and will usually approach their main banker when sourcing for financing. Don’t just assume your OCBC business loan will be the cheapest if you’re banking exclusively with OCBC.
Always compare and negotiate. If you do not have the resource and time to compare all available funding options, you can also consider outsourcing the task to a competent SME loan broker.
Obtaining a loan isn’t bad per se especially if your business will prosper from the funding it gets. But do remember that when you default on your payments, there’s always the risk of getting a bad credit rating, losing your asset or worse, losing a business.