SBA loan default and forgiveness explained

When you can't make payments on your SBA loan, the stakes can be high. Most SBA loans come with personal guarantees that can put your personal assets at risk. It is even possible for the SBA to foreclose on your home pledged as collateral. 

Before it gets to that point, you may be able to settle your SBA loan debt and get part of the debt forgiven. Here's what you need to know about SBA loan default, how the collection process works, and what SBA loan forgiveness really means.

Jason Milleisen, founder of New Jersey-based Distressed Loan Advisors, which helps business owners navigate SBA loan forgiveness, encourages SBA borrowers who are having trouble paying their debt to “deal with it head on,” and get professional help if needed. 

What does SBA loan forgiveness really mean

Loan forgiveness in the context of 7(a) loans (except certain COVID loans) is available through an Offer in Compromise (OIC). If you cannot pay your SBA loan, you may be able to negotiate a settlement that allows you to pay off the debt for less than the full balance (OIC), and get the rest of the balance forgiven. 

This is not automatic, and you won’t qualify if you are paying on time, or if you can afford to pay your loan in full. But it may be an option if you have fallen behind, cannot pay off the full debt but can make a reasonable offer to resolve it, and can’t (or don’t want to) wipe out the debt through bankruptcy. 

First, some quick background:

The 7(a) loan program is the largest and most popular SBA loan program for small businesses. It includes standard SBA 7(a) loans, SBA Express loans, SBA Small Loans, SBA Working Capital loans, Export loans, and more.

With the exception of Disaster Loans — including Economic Injury Disaster Loans (EIDL) — the SBA is not a lender. Private lenders issue SBA loans with a federal guaranty that covers up to 85% of the loan amount. This protects the lender, not the borrower. 

How little can you settle for? The SBA will determine it on a case-by-case basis depending on how much you can afford to pay. We’ll discuss this in more detail shortly. 

Offer in compromise eligibility

An offer in compromise is an agreement that lets you settle your SBA loan debt for less than the full amount owed. Any remaining balance is forgiven. An OIC is not meant to solve short-term cash flow problems.

Here’s how the SBA guidelines describe it:

“SBA will accept an offer in compromise if it reflects the Obligor’s true ability to pay. SBA will reject an offer if the Obligor can pay the Loan in full via a lump sum payment or an installment agreement, or if acceptance of the offer would harm the integrity of the 7(a) Loan program.” 

SBA guidelines also state that borrowers “do not have a ‘right to compromise’ the amount owed on their 7(a) Loan.”

With that background, here are the basic eligibility requirements: 

• Loan must be in liquidation status: The lender should classify the loan as being in liquidation. (In other words, you won’t be eligible for an OIC if you are still making your current payments but anticipate problems paying.) 
• Borrower cannot be in active bankruptcy: The person making the offer must not currently be in bankruptcy, unless the bankruptcy court has permitted the compromise action. (These loans may be dischargeable in bankruptcy.) 
• The full amount cannot be recovered: The SBA will take into account these factors to help them decide whether you can’t pay back the full loan: 
• Time is a factor: You aren’t able to repay the loan in a reasonable period of time, or the balance can’t be collected through legal proceedings within a reasonable period of time.
• The lender is unlikely to prevail in court. If you are sued, there is a significant likelihood the lender/SBA won’t win.
• Collection costs are too high. The projected cost of collection is more than the amount the lender/SBA expects to recover.
• Special circumstances that could lead to hardship: Repayment would cause the obligor financial hardship given special circumstances (e.g., illness).
• No legal barriers to collection: Collection of the loan balance is not barred by valid legal defenses like discharge in bankruptcy.
• No fraud or misconduct: You haven’t engaged in fraud, misrepresentation, or other financial misconduct. 
• Reasonable compromise amount: The compromise amount must have a reasonable relationship to what the lender/SBA could recover through legal collection proceedings and must protect the integrity of the 7(a) loan program.

Your business will also likely have to be closed. 

While the SBA guidelines include the option of an OIC for a business that continues to operate, “in practice I have not seen the SBA approve anything like that in many years,” says Milleisen, who is a former vice president for one of the country’s largest SBA lenders and oversaw a delinquent SBA loan portfolio in excess of $400,000,000.

If you manage to get an OIC approved and your business will continue operating, the SBA guidelines offer additional eligibility requirements:

• Compromise necessary to avoid closure: The business cannot continue under its current debt structure.
• All other options exhausted: This includes the sale of non-essential assets and closure of non-profitable segments/locations. (Do not, however, sell assets without consulting your lender.)
• Passes feasibility test: The borrower must pass the feasibility test for a successful workout.
• Part of overall debt restructuring: Must involve all of the borrower's creditors with a detailed creditor list required. 
• Fair and equitable treatment: The 7(a) loan treatment must be comparable to treatment of other creditors. (In other words, don’t expect the SBA to allow you to get part of your SBA debt forgiven while you pay other business loans in full.) 

When should you apply for forgiveness?

When it comes to timing, you can only apply for an offer in compromise after receiving an SBA demand letter following default. The demand letter comes from the SBA with a 60-day response deadline. This window of time is your chance to submit an offer and supporting documentation showing you cannot pay the full amount. You can start preparing earlier, but the SBA demand letter typically triggers the formal 60-day response window for settlement/compromise submission.

Before you consider trying to settle your loan, here are some key factors you’ll want to take into account:

• Personal guarantees: Most SBA loans require a personal guarantee from each owner with 20% or greater ownership. (Again, exceptions were made for certain COVID loans.) The personal guarantee means the SBA may expect certain personal assets to be used to cover the loan balance.  
• Each owner is liable: If your business has multiple owners with 20% or greater ownership, each one of those borrowers is responsible for the entire balance. Each one may need to negotiate based on their individual ability to pay back the loan.

The SBA guidelines are very clear on this point: “Lenders may request full payment from one or all the Obligors. Lenders should make no attempt to divide payment responsibility between the Obligors or use the compromise amount with one Obligor as the basis for the compromise amount required from another.” 

• Guaranty: The government guarantee protects the lender, not the borrower. Milleisen notes borrowers may think that if the government guaranty covers 75% of the loan balance, they only have to worry about the remaining 25%. “It doesn’t work like that,” he says in blog post for his business. “When the bank reimburses the lender, it just shifts the loss from the lender to the SBA.”
• Liens: The SBA generally files a UCC lien against business assets when you get an SBA loan. You must consult with the SBA before selling or disposing of assets. If you do not, this can scuttle your attempt to settle. 
• Forgiveness: An OIC settles the debt for less than the full amount, but it is not total forgiveness of the loan like Paycheck Protection Program (PPP) loans offered. 

Again, you may want to talk to a bankruptcy attorney to find out whether bankruptcy is a better option than settling. 

How to prevent SBA loan default

If you are having trouble making your SBA loan payments, take action as soon as possible.  It’s the same as any business loan – whether there’s an SBA guarantee or not – if you simply stop paying, you may find yourself with fewer options. 

Contact your lender early

Call your lender if you are having trouble making your payments on time. The lender may be able to offer a workout arrangement to help you avoid defaulting on your debt. 

A workout agreement doesn’t require SBA approval like an OIC does, though it must follow SBA guidelines. 

Workout options for 7(a) loans: forbearance and deferment

You may want to explore these workout options with your SBA lender: 

1. Forbearance: The lender agrees to pause collection efforts for a set period, giving you time to get your finances in better shape.
2. Deferment: Temporarily pause or delay your loan payments (principal and/or interest) to help you get through a short-term cash crunch.
3. Reinstate or extend maturity date: If the lender called your entire loan due, they may reverse that decision or give you more time to pay off the loan.
4. Modification of note repayment terms:
5. • Lower your monthly payment amount.
   • Reduce your interest rate.
   • Extend how long you have to repay the loan.
6. Assumption of loan: Transfer the loan to someone else who takes over responsibility for paying it (usually in the sale of the business). 
7. Subordination to working capital loan: Allow you to get a short-term loan that gets paid before the SBA loan if you default
8. Relief for secured senior loan: The lender helps you catch up on another loan that has priority over the SBA loan, or pays it off completely.
9. Voluntary sale of collateral: Sell the assets that secure your loan (like equipment or property) with the lender's supervision, using the money to pay down your loan balance. Get the lender’s permission before you dispose of assets. 

Note that none of these workout options reduce what you owe. If debt forgiveness is your goal, you must go through the formal OIC process or consider bankruptcy. 

Document cash flow hardship

Lenders won't negotiate a workout if you can’t or won’t provide financial information to back up your request. You’ll need to provide: 

Financial statements

• Current personal financial statements from all borrowers and guarantors, signed under penalty of perjury showing assets, liabilities, income, and expenses. SBA Form 770 is typically used here. 
• Business's most recent year-end financial statements (including accounts receivable aging and debt schedules).
• Financial statements for any affiliated businesses.

Business tax returns

• Complete copies of the business's federal tax returns for the past two years.
• Complete copies of federal tax returns for any affiliated businesses.
• Written explanation if returns are unavailable.

Personal tax returns

• Complete copies of personal federal tax returns from all borrowers and guarantors for the past two years.
• Written explanation if returns are unavailable.

Don’t try to hide assets. The SBA can check credit reports and other sources of financial information to verify what you’ve shared. 

Consequences of defaulting on an SBA loan

“The SBA loan collection process can be scary and hard to predict,” says Milleisen.  “Decisions vary from bank to bank, banker to banker, and even between SBA workout offices.” 

Impact on credit

According to SBA guidelines, lenders are required to report information about 7(a) loans to the appropriate credit reporting agencies. Since these are business loans, that typically means information will be reported to one or more of the major business credit bureaus: Dun & Bradstreet (D&B), Equifax, or Experian.

Information reported will include:

Identification information:

• Account number
• Taxpayer Identification Number (TIN/EIN)
• Business name
• Business address

Debt information:

• Type of debt (loan, overpayment, fee, etc.)
• Date debt initiated
• Original amount of debt
• Maturity date
• Payment frequency (monthly, quarterly, etc.)
• Whether the loan is secured

Current account status:

• Current status (current, delinquent, in default, in collection, foreclosed, paid in full, etc.)
• Amount of debt outstanding
• Past due amount
• Date of most recent payment
• Date of violation (when account became delinquent)

Agency information:

• Contact person name and phone
• Federal creditor agency (SBA)

Reporting schedule: Commercial accounts (business accounts) are reported quarterly while consumer accounts report monthly. 

Late payments, default, or collections can hurt your business credit scores and can make it harder to get future business loans, qualify for business credit cards, lease commercial space or land contracts involving credit checks. 

If you are closing your business, this may not be a major concern, but if you are trying to keep it open, negative information can make it difficult to rebuild your business credit. 

Personal guarantee triggers

Typically, 7(a) loans include a personal guarantee (with some COVID loan exceptions). If you don’t pay back your loan, personal assets may be at risk, including:

• Personal bank accounts
• Home equity pledged as collateral
• Wage garnishment from any job you hold
• Other personal assets

That also means that if your business fails, you aren’t necessarily off the hook for the loan balance. 

Lender vs. SBA vs. Treasury collection chain

Don’t expect a quick answer to your OIC request. “I always tell people that they can count on the OIC process taking at least four to eight months,” Milleisen says. 

Your lender has agreed to service your 7(a) loan (and has been paid a fee to do so), so you will be dealing with your lender until the loan is considered uncollectible.

If it gets to the stage where the lender does not believe it can collect, the debt will be designated as uncollectible and the SBA will be notified by the lender. 

The SBA then sends the 60-day demand letter. At that time you can submit your OIC, or explore other options such as bankruptcy.

If those efforts are not successful, or you do not respond, your loan will be referred to the Department of Treasury for collection. 

“SBA generally wants the lender to pursue litigation” if they believe there are significant assets available, Milleisen says. “In cases where they don't believe litigation is worth it financially, that's when the file gets referred to the US Treasury.”

Lenders must always operate within SBA guidelines, but beyond that each lender may handle your loan servicing differently. That leads to some uncertainty that can be stressful. In general, the earlier you act, the more options you’ll likely have. 

SBA demand letter: Respond in 60 days

When the SBA sends you a demand letter, the clock starts ticking. You have up to 60 days to respond.

This is your window to submit an offer in compromise and avoid Treasury collections, if that’s how you decide to handle your debt. If you miss this deadline, your debt moves to the Treasury Offset Program and your options become much more limited.

The process for applying for OIC is explained in more detail below. 

Avoiding the Treasury referral

When your debt lands at the Treasury Department, settlement becomes much harder.

“Once the bank deems your account to be uncollectible, they will refer it to the US Treasury, who will add a hefty 28% penalty to your loan balance, then demand at least 50% of the loan balance,” Milleisen says. He adds that he’s heard of penalties as high as 80%. 

If you want to try to settle your debt before that happens, submit your OIC response well before the 60-day deadline. If you need more time to gather documents, contact the SBA in writing to request a written extension before the deadline passes.

How to file an offer in compromise

An offer in compromise is your formal proposal to settle your SBA debt for less than the full amount. The key is making an offer the SBA can't get through other collection methods.

What goes into an offer in compromise amount

The SBA doesn't simply accept whatever you can afford to pay. Instead, they compare your offer against what they believe they can realistically recover by pursuing enforced collection, including taking you to court if necessary. 

The key question you need to ask yourself: Is your offer at least as good as what the SBA would collect through lawsuits, wage garnishment, and asset seizure — after accounting for the time, expense, and risk of going that route?

The SBA will calculate what it could recover by looking at these factors:

• Assets the SBA could seize: Recoverable value of any remaining loan collateral (like your personal residence if it secured the loan)
• Non-exempt personal assets like:
• • Home equity beyond (state or federal) exemption limits
  • Vehicles beyond exemption limits
  • Investment accounts
  • Cash and bank accounts
  • Business assets
• Income they could garnish:
• • Your current income through administrative wage garnishment.
  • Your future earning capacity based on age, health, and employability.
• Deductions from income eligible for garnishment:
• • Exemptions: State and federal law protects certain assets from seizure (this varies by state).
  • Collection costs: Attorney fees, court costs, and time to pursue legal action.
  • Litigative risk: Chance they might lose in court due to legal defenses or factual disputes.
  • Time value: Money collected years from now is worth less than money today.

Factors that may help strengthen your offer in compromise:

• Financial hardship: Medical conditions, disability, or circumstances that genuinely limit your ability to pay may reduce the amount they expect to be able to collect. You'll need to explain these special circumstances in your written offer.
• Your cooperation: If you've been transparent and helpful during liquidation (rather than hiding assets or being uncooperative), the SBA may view your offer more favorably.
• Older age or health issues: These factors may affect your future earning capacity and the SBA's ability to collect over time.
• Risk you'll hide assets: The SBA considers whether pursuing you through courts might lead to asset concealment or fraudulent transfers that make collection harder.

Minimum offer amounts

The SBA generally won't consider offers under $5,000 unless there's a documented financial hardship that makes even that amount impossible for you to pay, or for the government to collect. 

For a hardship exception, the criteria is that if $5,000 would genuinely cause financial hardship (based on your income, expenses, and circumstances), you can offer less, but you'll need strong documentation.

Remember, the SBA must protect the credibility of its loan programs. Taxpayers are ultimately on the hook for unpaid federal debt. That means they won't accept offers that are so low they'd encourage future borrowers to default expecting easy settlements. Your offer needs to be reasonable not just for your situation, but for maintaining the integrity of the program.

Be aware that low-ball offers typically get rejected. 

“If you ignore the bank and hold out for a pennies-on-the-dollar settlement,” Milleisen says, “You’ll be waiting forever.”

For example, if you own a home with $100,000 in equity above your state's homestead exemption, and you have now taken a job with a good income, don't offer $5,000 to settle the loan. The SBA knows they could garnish your wages and eventually even force the sale of your home to satisfy the debt.

Lump sum vs. installment offers

There are two ways these offers may be structured: 

• Lump sum: Pay the entire settlement amount in one payment within 90 days of acceptance. These tend to get approved more often because the SBA gets paid quickly and closes the file.
• Installment: Pay the settlement amount over time, up to 36 months. This type of offer is harder to get approved, because the SBA knows borrowers may not be able to keep up with their payments. But it is a possibility depending on your circumstances. 

If you are approved for an installment program and miss a payment, you go back to owing the full amount of the debt (not the negotiated balance) minus any payments you made in the meantime. 

If you can scrape together a lump sum — even by borrowing from family or retirement accounts — you'll have better chances of acceptance.

Documentation you'll need: 

Here the essential documents you’ll need to submit with your request for an OIC: 

1. Written offer (SBA Form 1150)

• Identify the source of funds for the offer.
• Explain any special circumstances (like illness causing financial hardship.)

2. Current personal financial statement (SBA Form 770)

• Shows all assets, liabilities, income, and expenses.
• If you have affiliate businesses, provide financial statements for each.

3. Personal federal tax returns

• Complete copies for the most recent two years.
• Written explanation if unavailable.
• Executed IRS Form 4506-C or Form 8821 (for tax transcripts.)

4. Business federal tax returns (if business is still operating)

• Complete copies for the business for the most recent two years.
• Complete copies for any affiliate businesses for the most recent two years.
• Written explanation if unavailable.
• Executed IRS Form 4506-C or Form 8821.

5. Business year-end financial statements (if business is still operating)

• Most recent year-end statements.

The lender will also pull a current credit report to verify your financial information independently. Be thorough as missing documentation gives the SBA an easy reason to reject your offer.

Approval odds

While you probably hope you can get a clear idea of how likely your OIC request is to get approved, it will depend on your unique circumstances and your ability to pay. 

“Clients that I've had who settled for four or five cents on the dollar were really down and out financially,” Milleisen says. “These types of settlements are the exception, not the rule.” He says that those very low settlements are not typical today. 

Common reasons your request may be rejected include: 

• Incomplete or missing documentation.
• Offer too low compared to your assets and income.
• Evidence you could pay more if you adjusted your lifestyle.
• Recent asset transfers that look like you're hiding money.
• Lack of a clear hardship explanation.

If your offer gets rejected, you're still liable for the full debt amount and Treasury collections move forward.

Treasury collections after offer rejection

If you don't respond to the SBA demand letter or your offer in compromise gets rejected, your debt transfers to the U.S. Treasury Department for collection under the Treasury Offset Program. Here are some potential consequences:

Social Security or tax refund offsets

Treasury may be able to intercept money the government owes you:

• Federal tax refunds
• State tax refunds (in some cases)
• Social Security payments
• Federal retirement benefits
• Federal wages if you work for the government

There may be limits on the amounts that can be taken from these sources, and while you’ll receive notice before these offsets happen, you aren’t likely to be able to stop them. 

Wage garnishment limits

The federal government can garnish up to 15% of your disposable income from any private employer. Disposable income is what's left after required deductions like taxes and Social Security.

The garnishment comes out of every paycheck until your debt is satisfied. Your employer must comply with this garnishment — they have no choice.

Unlike private creditors, the federal government doesn't need a court judgment to garnish your wages. They can start garnishment with written notice.

No statute of limitations

Most private debts have a statute of limitations — typically two to six years depending on the type of debt and state law. After that, if creditors sue you to collect, you can raise the statutes of limitations as a defense against the lawsuit. 

SBA loans are different. While there may be time limits for the federal government to sue to collect a debt, if it takes that step, it typically can collect until the debt and applicable penalties are repaid. 

What about EIDL Loans?

The SBA is not currently offering forgiveness for COVID-EIDL loans. (COVID-EIDL grants were forgivable, but not loans.) 

However, one major difference between COVID-EIDL loans and other SBA loans is that balances of $200,000 or less did not require a personal guarantee. 

This may change in the future, so check frequently for updates on the SBA website.

This article provides general information and isn’t legal or tax advice. Talk with a qualified attorney or tax professional about your specific situation.

Documentation you'll need: 

Here the essential documents you’ll need to submit with your request for an OIC: 

1. Written offer (SBA Form 1150)

• Identify the source of funds for the offer.
• Explain any special circumstances (like illness causing financial hardship.)

2. Current personal financial statement (SBA Form 770)

• Shows all assets, liabilities, income, and expenses.
• If you have affiliate businesses, provide financial statements for each.

3. Personal federal tax returns

• Complete copies for the most recent two years.
• Written explanation if unavailable.
• Executed IRS Form 4506-C or Form 8821 (for tax transcripts.)

4. Business federal tax returns (if business is still operating)

• Complete copies for the business for the most recent two years.
• Complete copies for any affiliate businesses for the most recent two years.
• Written explanation if unavailable.
• Executed IRS Form 4506-C or Form 8821.

5. Business year-end financial statements (if business is still operating)

• Most recent year-end statements.

The lender will also pull a current credit report to verify your financial information independently. Be thorough as missing documentation gives the SBA an easy reason to reject your offer.

Approval odds

While you probably hope you can get a clear idea of how likely your OIC request is to get approved, it will depend on your unique circumstances and your ability to pay. 

“Clients that I've had who settled for four or five cents on the dollar were really down and out financially,” Milleisen says. “These types of settlements are the exception, not the rule.” He says that those very low settlements are not typical today. 

Common reasons your request may be rejected include: 

• Incomplete or missing documentation.
• Offer too low compared to your assets and income.
• Evidence you could pay more if you adjusted your lifestyle.
• Recent asset transfers that look like you're hiding money.
• Lack of a clear hardship explanation.

If your offer gets rejected, you're still liable for the full debt amount and Treasury collections move forward.

Treasury collections after offer rejection

If you don't respond to the SBA demand letter or your offer in compromise gets rejected, your debt transfers to the U.S. Treasury Department for collection under the Treasury Offset Program. Here are some potential consequences:

Social Security or tax refund offsets

Treasury may be able to intercept money the government owes you:

• Federal tax refunds
• State tax refunds (in some cases)
• Social Security payments
• Federal retirement benefits
• Federal wages if you work for the government

There may be limits on the amounts that can be taken from these sources, and while you’ll receive notice before these offsets happen, you aren’t likely to be able to stop them. 

Wage garnishment limits

The federal government can garnish up to 15% of your disposable income from any private employer. Disposable income is what's left after required deductions like taxes and Social Security.

The garnishment comes out of every paycheck until your debt is satisfied. Your employer must comply with this garnishment — they have no choice.

Unlike private creditors, the federal government doesn't need a court judgment to garnish your wages. They can start garnishment with written notice.

No statute of limitations

Most private debts have a statute of limitations — typically two to six years depending on the type of debt and state law. After that, if creditors sue you to collect, you can raise the statutes of limitations as a defense against the lawsuit. 

SBA loans are different. While there may be time limits for the federal government to sue to collect a debt, if it takes that step, it typically can collect until the debt and applicable penalties are repaid. 

What about EIDL Loans?

The SBA is not currently offering forgiveness for COVID-EIDL loans. (COVID-EIDL grants were forgivable, but not loans.) 

However, one major difference between COVID-EIDL loans and other SBA loans is that balances of $200,000 or less did not require a personal guarantee. 

This may change in the future, so check frequently for updates on the SBA website.

This article provides general information and isn’t legal or tax advice. Talk with a qualified attorney or tax professional about your specific situation.

Frequently asked questions