What happens when you default on an SBA loan?

Key points about SBA-guaranteed loans and what happens if you cannot repay:

1. How an SBA loan really works

- The U.S. Small Business Administration (SBA) does not lend money directly to business owners.

- You borrow from a commercial lender (bank, credit union, or non-bank lender).

- To encourage the lender to approve the loan, the SBA promises to reimburse the lender for a portion of any loss—typically 50 %, 75 %, or 80 % of the unpaid balance—if the borrower defaults.

2. What happens if you stop making payments

- Because the note is a regular bank loan, you first default **with the bank**, not the SBA.

- Federal regulations require the lender to try to recover what it can by liquidating any collateral (business assets, personal guarantees, real estate, etc.).

- After liquidation, the lender submits the remaining deficiency to the SBA and receives the guaranteed percentage.

3. How the government collects the deficiency

- Whatever the SBA pays to the lender becomes a debt you now owe **to the U.S. government**.

- The SBA refers this debt to the U.S. Treasury for collection, and the Treasury can use the Internal Revenue Service (IRS) and other federal collection tools.

- One common step is issuance of Form 1099-C (Cancellation of Debt). The canceled amount is reported as ordinary taxable income, which means you may owe income tax on that sum.

- The Treasury Offset Program can intercept future federal tax refunds, Social Security benefits, and other federal payments until the debt (and any associated tax liability) is satisfied.

4. Possibility of negotiating—Offer in Compromise (OIC)

- Before the debt is transferred for collection, you can propose an **Offer in Compromise** to the SBA.

- You submit financial documentation and offer a lump-sum or structured payment that represents the most you can reasonably afford.

- The SBA may accept, counter, or reject the offer. If rejected, the full deficiency proceeds to Treasury/IRS collections.

5. Consequences of default

- Severe, long-lasting damage to personal and business credit.

- Potential loss of pledged collateral and personal assets.

- Ongoing federal collections and tax liabilities until the debt is resolved.

- Legal costs and additional interest or penalties can accumulate.

6. Bottom Line

An SBA guarantee protects the **lender**, not the borrower. To avoid collateral liquidation, tax consequences, and federal collections, stay current on loan payments or contact the lender immediately if trouble arises. Repayment, restructuring, or a successful Offer in Compromise is far less costly than allowing the loan to default.