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SBA Loan Default – Can you Discharge SBA Loans in Bankruptcy?

In my years as a workout officer for the largest SBA lender in the country, borrowers filing for bankruptcy was par for the course.  Whenever you combine lots of money owed with little chance of paying it back, the prospect of bankruptcy in one form or another is always lurking.

If you are facing an SBA loan default because you or your business can’t afford the payments, chances are that bankruptcy has crossed your mind.  Today, I’d like to cover the most common questions that borrowers ask when it comes to an SBA loan default and bankruptcy.

Can an SBA loan default be discharged in bankruptcy?

Yes, I’ve seen plenty of chapter 7 BK filings as a workout officer.  As a consultant, I’ve also had my fair share of clients who retained me to after a BK.  The reason they retained me was because despite having their personal guarantee released, the lender still had a lien on their home.

Wait, A Bankruptcy Doesn’t Get The Lien Released?

So while a personal guarantee can be discharged, a lien on your personal residence will remain intact if there is equity in your home.  This is an important fact to know, as I’ve received calls from more than one upset borrower who only learned that the lien stayed in place AFTER they went through the BK.

For many borrowers with equity in their home, but without much else in the way of personal assets, each of these scenarios may result in a similar cost:

  1. File a BK, then negotiate a lien release after the fact, or
  2. Negotiate an SBA loan default Offer In Compromise (OIC) and have a release of the lien be included as part of the OIC.  

If it’s going to cost the borrower the same, most people would just as soon avoid having a BK on their record.

When’s the best time to seek a lien release following a bankruptcy?

I generally believe that the sooner you do it, the better.  There are a couple of reasons why I recommend this:

  1. While the real estate markets can experience declines here and there, over the long term real estate has historically increased in value over time.  If your home is worth $300K today, it’s likely to be worth more 5 to 10 years from now. If you attempt to negotiate a lien release when your home is worth more, there will be more equity and therefore it will cost you more to have that lien released.
  2. As long as you continue to pay down your mortgage, you will continue to build equity in your home (assuming the value of your home increases or stays flat).  As in the point above, the less you own on your first mortgage, the more equity in the home.

The bottom line on lien releases is this: the more equity you have in the home, the more the bank will demand from you in order to release it.  In general, equity increases over time due to rising prices and paying down your mortgage, which means the longer you wait, the more it’s likely to cost you to negotiate a lien release.  Lenders negotiate based on equity that exists today, so you should use that to your advantage.

Legal Contributor:

Jason Tees

Jason Milleisen is the founder and owner of Distressed Loan Advisors (JasonTees.com).  Since 2009, DLA has helped hundreds of small business owners through the SBA Offer In Compromise process, resulting in over $50 Million saved.  Jason is a former workout officer for the largest SBA lender in the US, where he oversaw a $400 Million portfolio of delinquent SBA loans.

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