This is the question clients ask us every day. Almost every borrower wants to pay their bills, but when financial disaster strikes, it is not always possible to fully repay your debts when you are forced to close your business and walk away. Luckily the SBA has a particular program, designed for borrowers looking to avoid bankruptcy and make a good faith settlement with their lender.
Clients in difficult financial positions always want to pay as little as possible on their defaulted SBA loans, but what is the minimal amount possible that one could settle for? This is never very simple, and it is a negotiation that must be handled very delicately. The short answer is this; you can settle for an amount equivalent to what the lender would obtain from you through forced collection tactics. Here is how your SBA loan offer in compromise is calculated through the eyes of your banker.
When a borrower of an SBA guaranteed loan enters default, several things occur. One, the borrower, almost always the business entity involved in obtaining the financing, faces liquidation in an effort for its creditors to get as much of the defaulted loan’s balance as possible. When the borrower has been completely liquidated, the creditor then turns to the guarantors, in most cases the guarantor is the actual person who signed the loan documents and sometimes family and friends as well guaranteed the debt.
The first thing to understand is that the SBA guaranteed loan obligates the guarantors both jointly and severally. This means that although there is one total balance that all guarantors owe together, they are treated as individual sources of collection. If there are five guarantors, do not assume you only owe 20% of the debt, each of you is obligated to the full 100% of any outstanding balance, and the SBA will pursue whoever they feel has the most resources or could most easily be collected upon.
There are many factors considered in the process that calculates how much your creditor believes you are worth to them, but these four factors we find are the most important when the lender makes their decision:
- Value of current assets
- Future earning potential
- Cooperation and character
- Costs of collection
1. Value of current assets – This should be the most obvious when calculating your SBA loan offer in compromise settlement offer. Adding the values of all major assets such as the equity in your home, cash, bank accounts, vehicles, investment real estate, etc. and subtracting all liabilities secured against such assets can calculate the current equity in your assets. There are laws that help debtors shield assets from creditors such as your state’s homestead exemption, retirement account protections, college savings, and wage garnishment protections. You can look at this reference guide for some that exist in your State.
However, do not feel that you are going to settle for $0 when your assets are all unreachable. The SBA loan offer in compromise settlement is a privilege, not a right. You are working in good faith with your banker to avoid the high costs and stress of going through bankruptcy or litigation. For example, if you are living in Texas (your homestead is protected) in a $500,000 home that has no mortgage, it is unreasonable to think the bank will forgive you of $250,000 of defaulted debt for pennies on the dollar. The equity in the home might be unreachable to the creditor, but they are unlikely to just “let you off the hook” when it is very apparent that you can pay the debt off in full. However, if the debt was $800,000 and you didn’t have the ability to refinance the full amount of equity from your home, you could likely negotiate something far less than what is owed.
2. Future earning potential – This is a definite factor in every SBA loan offer in compromise settlement negotiation, but the calculation is much vaguer. It takes into account your present employment and earnings, your previous earning history, age, and health. From these major factors, the lending creditor will determine what value they could obtain through a method such as wage garnishment. State level protections can mitigate garnishment exposure especially if you are the head of household and have many dependents. It is important to understand that garnishment is taken after involuntary wage deductions, but from gross earnings. This means that the amount it taken directly after social security, Medicare, federal income tax, and other mandated deductions occur and before your health insurance, 401k deduction, or any other voluntary deduction is considered. Garnishment is a long process and has inherent costs to your creditors, if you can obtain a lump sum to provide for your offer, you can often successfully offer a dramatically lower amount than garnishment would obtain because it is much more valuable for the creditor to get cash now.
3. Cooperation and character – is possibly the most critical factor in getting an Offer In Compromise acceptance and determining what you must pay to succeed. During the liquidation of a borrowing entity and any review of financial condition of guarantors, your creditor will ask for and expect your cooperation and active participation. Arranging appraisals of the physical assets and providing financial reports will show that your intention is to help the creditor recover as much as possible against the defaulted balance and will be a critical factor in offer negotiations. Many clients who ignored their creditors until they were sued have a much harder time obtaining the best possible offer amount.
4. Cost of collection – refers to the amount your creditor must pay to enforce their collection rights legally. Everything from mailing you a default letter to foreclosing on your home will cost your creditor money. These costs are more prohibitive to your creditor, the longer they go on. This means that your creditor has an incentive to take a small amount now rather than collecting the full balance through legal collection over an extended period of time.
Paperwork is also critical in creating the best offer proposal. The SBA will only ask for two standard forms, the SBA form 770 and 1150 and your tax filings for two years, but there are many more documents you should supply if you want to be successful. Any number, fact, or item provided to your creditor should be proven with some third party document. This means on the personal financial statement used in the offer process, SBA form 770, if you list a mortgage balance, you should also include your most recent statement to document where your information was obtained and most importantly, you want to write a convincing hardship letter.
It is the hope of Second Wind Consultants this information helps anyone in need of an Offer In Compromise, but I urge anyone entering into this process to obtain representation. Every case is unique, and these are only general guidelines to consider.