If you have multiple business debts, you may be considering business debt consolidation to simplify your payments. Here's what you need to know before deciding if it's right for your business.
Business debt consolidation combines all of your loans into one, which can lower your interest rates and decrease your risk of accidentally missing a payment. However, debt consolidation isn't for everyone. Before you combine your loans, learn how debt consolidation works and its benefits and risks.
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How does business debt consolidation work?
Business debt consolidation is similar to personal debt consolidation. By consolidating all of your business loans into a debt consolidation loan, you can streamline them into one fixed payment and decrease your interest rate, which makes your debt easier to manage.
Consolidation is recommended for business owners who feel overwhelmed with paying multiple creditors various payments every month. Only having to worry about a single payment can help you budget expenses and makes it less likely that you'll miss a payment that could ding your credit score.
When consolidating loans, consider the amount of debt relief you need, since the loan should be enough to cover your debts. For instance, if you're approved for a consolidation loan for $10,000 but you have $25,000 in debt, it won't make sense to consolidate. [Read related article: How to Choose a Business Debt Consolidation Loan]
Does debt consolidation hurt your credit?
Consolidating your debt can lower your monthly loan payments, but it can also cause a temporary dip in your credit score. When you apply for a debt consolidation loan, the lender will make a hard inquiry on your credit, which can lower your credit score by a few points.
However, if you pay your bills on time, you should be able to regain the credit score points quickly. If you need to lower your annual percentage rate (APR) and monthly bills, a temporary dip in your credit score is worth the long-term goal of improving your finances.
Consolidating your debt into one loan may also help you get approved for future loans. When a lender looks at your credit history, they don't like to see a list of various loans. If you think you might need an additional loan soon to support growth or sustainability, business debt consolidation can help you clean up your credit report.
What is the difference between debt consolidation and a loan?
Since debt consolidation is one of the many ways you can use a business loan, there is virtually no difference between the two.
A debt consolidation loan is simply a business loan that you have designated for paying off other high-interest debts. By using the loan to pay off your existing business debt, including credit card balances, you simplify your finances, replacing multiple payments with one fixed monthly payment.
When should you consolidate business debt?
If you have good credit and a moderate amount of debt, consolidating your business loans can save you money in interest over the long term. It can also streamline your monthly payments so you only have to remember to make one payment each month.
Before consolidating, make an honest report of your finances. Determine what debt payment you can comfortably make every month with your current cash flow. Look at your monthly costs and see where you can afford to make budgetary cuts.
Consolidating business debt is only effective if you change your spending habits. By recognizing your spending triggers and seeking financial advice from your accountant, you can save your business from running into the red.
When is it a good idea to consolidate debt?
It is wise to consolidate debt when you are feeling overwhelmed with tracking multiple payments, but the best reason is a lower interest rate.
If your debts have high APRs, such as business credit cards that average 14.21% to 22.16% APR, but you qualify for a business loan with a low APR – such as from a traditional bank with an average interest rate between 2% and 13% – you may be able to save money on interest. [Read related article: Best Practices to Follow Before Applying for a Small Business Loan]
How many times can you consolidate business debt?
While you can technically consolidate your business debt multiple times, the consolidation process isn't the hard part. Recognizing that you have an overspending issue is the first step in getting a handle on your debt.
Using any form of debt consolidation to bandage a larger debt so you can continue to spend won't solve any problems. If you don't reflect on how you accumulated your debt, you will fall back into the same habits and potentially get into a hole you can't climb out of financially.
You can get back on track by creating a budget, tracking your spending and mentally preparing for any spending hiccups. Once you pay off your debt in full, consider depositing the cash you were previously paying on your loan into a business savings account. You can then use that account to pay for unexpected expenses upfront, saving you time and avoiding the fees of obtaining another loan. [Read related article: Requirements for Getting a Small Business Loan]
What are the risks of business debt consolidation?
As with any loan, you must carefully consider the costs and risks of debt consolidation. Here are eight to watch out for.
New loan fees: When you apply for a business debt consolidation loan, the lender can tack on fees for the application and approval process. These fees are often added to your original debt, increasing the monthly payment.
Extended loan term: Lowering your monthly payments tends to increase the number of months it will take to pay off the loan in full.
Interest rate qualifications: Finding a loan with a lower interest rate to consolidate your debt under is only possible with good credit and minimal debt. Use a loan calculator to see if a small reduction in your interest rates will make a difference in the total amount you pay over time. If you are already a few years in, or you have bad credit or too much debt, there's a chance you won't save any money by consolidating your business loans.
Prepayment penalty: If you're planning to pay extra money each month on the principal of your loan to pay it off faster, check the fine print of your loan agreement to verify that there's no prepayment penalty. Lenders add this clause to loan terms to ensure they make the maximum amount of money in interest on your loan.
Consolidation scams: Consumers and business owners get scammed every year by debt consolidation lenders. Stay away from these companies, and instead research DIY solutions such as balance-transfer credit cards with no annual fee and business loans. You can often find these through your financial institution or online vendors. Always go with a company that you have researched and trust.
Collateral: Some banks require collateral such as property, equipment or vehicles to approve a business debt consolidation loan. If you haven't taken the time to analyze your spending and commit to a strict budget, you could easily fall back into excess spending. Are you prepared to lose what you need to put up for collateral?
Credit score: If your credit score has already taken a hit from your debt, you may not qualify for a debt consolidation loan – or, if you do, the interest might not be any better than what you are paying now. A good credit score is essential to securing business loans. Always aim to make your debt payments in full and on time.
- More debt: Consolidating your debt can give you the illusion of having more money – especially if you use it to pay off business credit cards and then have more credit available. Refrain from charging purchases on these cards to avoid the burden of paying back even more debt. [Read related article: Hidden Gotchas in Your Business Loan Repayment Terms]
What fees are associated with debt consolidation?
Debt consolidation can take many forms, including traditional business loans from banks, SBA loans, alternative loans and business credit cards; some business owners even take out personal loans. No matter which you choose, though, fees are commonplace.
Consider all fees and interest rates when deciding whether consolidation will help your business pay off its debts. The types of fees you're charged, and the amounts of each, vary by lender and the specifics of your loan agreement. Here are some fees to look for before accepting a loan:
- Application fee
- Origination fee
- Guarantee fee
- Appraisal fee (for collateral)
- Annual fee
- Late fee
- Prepayment penalty
- Closing costs
Is business debt consolidation right for your business?
When you face debt from multiple creditors, it can feel unbearable. In some instances, business debt consolidation may simplify your payments and reduce your interest rate. Carefully research your options to ensure a business debt consolidation loan is the best solution for your business.