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What is business debt consolidation?
Consolidation is the act of taking all or part of your existing debts and fusing them under one loan. In short, you’re taking out a new loan, paying off all of the other loans, and only making one monthly payment.
Particularly when your business is just starting off, there can be lots of expenses that require loans. Locking down a physical space, hiring a team, and making sure you’ve got sufficient working capital are all expensive and can require external funding to get your company off the ground. Plus, some business owners need to take out high-interest loans or even personal loans to handle business expenses.
After some time in business, you might find that you’re overwhelmed by keeping track of a multitude of monthly payments that need your attention even if the size of those payments isn’t prohibitive. And if you miss a payment, there can be significant consequences for your credit. Consolidation means you’ve only got one payment, simplifying the entire process.
How to get started with business debt consolidation
So how do you get started with business debt consolidation? There are a few steps you should take, since it isn’t wide to consolidate debts willy-nilly, and your first option isn’t necessarily your best option.
Determine which debts to consolidate. The first step is to list out all of the business debts that you have, including the interest rate and monthly payment for each one. Then, prioritize which debts you want to pay off first. Typically, it makes the most sense to consolidate high-interest debt first. Some debt consolidation loan options will come with longer repayment terms than the smaller debts carry. While spreading out these debts over a longer time means you’re living with them on a longer term, it also means that monthly payments are often smaller, leading to lower payments and freed-up cashflow.
Research consolidation options. Once you’ve decided which debts you want to consolidate, your next step is to research your options. Many types of loan are available for consolidation depending on your business. Consider how your business has changed since you took out the loans you’re looking to consolidate. Do you have assets now that can be used as collateral to secure a better interest rate with a secured loan? Even if you’ve got bad credit, has it improved since the time you took out your existing loans? Your circumstances should dictate your lending options. Many term loans are eligible for consolidation, and government-backed Small Business Administration (SBA) loans are also a fantastic option, though you may struggle with the application process on SBA loans with bad credit.
Compare loan offers and choose the best one for your needs. Now that you know what kind of consolidation loan you’re looking for, it’s time to compare offers from different lenders. When comparing offers, be sure to pay attention to the interest rate, fees, repayment timeline, and any other terms and conditions that may apply. Remember, consolidation loans are intended to simplify repayments and free up cash for borrowers. If the terms offered by a potential lender don’t make your life easier or free up money, it might be wisest to consolidate debt at a later date.
Use the loan funds to pay off your debts. After you’ve been approved for the loan and received the funds, your next step is to use those funds to pay off your existing debts. Once you’ve paid off all of those debts in full, you’ll just have one consolidated loan left (hopefully with a low interest rate) to worry about.
Begin making payments on your consolidation loan. Now that all of your business debt has been consolidated into one loan, your final step is to begin making payments on that loan according to the terms of your agreement. Be sure to stay current on your payments so that you can avoid any late fees or penalties.
Debt Consolidation vs Debt Refinancing - What’s the Difference?
Many business owners have confusion between refinancing and consolidation, and it’s an understandable mistake. While consolidation and refinancing are both ways of changing the form of existing loans, they have different purposes and intentions.
Let’s say a business owner has three remaining loan amounts to pay off: $8,000 at 6.5% interest, $11,000 at 5.8% interest, and a $22,000 loan at 6.1% interest due to purchasing a vehicle.
Consolidation: If this business owner sought out consolidation, they would look for a loan that would pay off the $41,000 in remaining debt under a single loan. If their credit merits a lower interest rate, they might also find that they’re paying less.
Refinancing: This particular business owner may look to refinance that $8,000 loan. In refinancing, they’d receive a loan of $8,000 to pay off that debt with an interest rate below 6.5%, saving them money.
Both refinancing and consolidation are intended to ease the financial burden on business owners, and some business owners use them in conjunction to maximize savings. This is particularly effective if your credit has improved dramatically. You might consider consolidating multiple debts, then, down the line, refinancing the loan you received to consolidate.
The benefits of business debt consolidation
Lower Interest Rates
One of the biggest benefits of consolidating your business debt is that it can help you secure a lower interest rate. This is because when you consolidate your debt, you’re essentially taking out one new loan to pay off multiple existing loans. And, since lenders may see this as less of a risk, they’re often willing to offer lower interest rates on consolidated loans. This can save you hundreds or even thousands of dollars in interest payments over the life of your loan.
Fewer Monthly Payments
Another benefit of consolidating your business debt is that it can simplify your monthly payment schedule. Rather than having to keep track of multiple due dates and minimum payments, you’ll only have one monthly payment to worry about. This can save you precious time and energy that you can then put toward growing your business.
Improved Cash Flow
Consolidating your business debt can also improve your cash flow situation. This is because when you consolidate your debts, you can often reduce total loan payments by extending your repayment period. This will result in lower monthly payments, which can free up some much-needed cash flow for other aspects of your business. Additionally, consolidation can help you get out of revolving debt (like credit card debt) and into installment debt (like a term loan), which can provide more stability for your small business.
Mistakes to watch out for when consolidating your business debt
Of course, it’s not always wise to seek out consolidation. In fact, sometimes consolidation is a flat-out debt management error. Here are a few mistakes some business owners make when seeking consolidation.
Paying Too Much on Prepayment Penalties
It should be noted that some business loans come with prepayment penalties, and you’ll want to consider that as you search for the right consolidation loan. To avoid significant prepayment penalties, consult the fine print of your existing loans and determine if you may be willing to wait a bit before consolidating.
Not Shopping Around for the Best Rate
When you’re consolidating your debt, you’re taking out a new loan to repay your existing debts. That means you’ll want to shop around for the best interest rate and loan terms. Don’t just go with the first lender you find. Talk to several lenders and compare rates before making a decision. Be patient, and make the right match for your business’s needs.
Not Knowing the Impact on Your Credit Score
Another mistake people make when consolidating their debt is not knowing the impact it will have on their credit score. If you have bad credit, consolidating your debt could hurt your score because it will likely involve opening up new accounts, and the age of your debt is a significant part of your company’s credit score.
A short-term dip in your credit score is not the end of the world, and the cash flow freed up by a consolidation loan may allow your business to thrive down the road and boost your credit well past where it was at the time of the loan. But be aware of the fact that the next time you check your business’s credit history, the numbers may very well have gone down.
Failing to Change Your Spending Habits
Finally, one of the biggest mistakes people make when they consolidate their debt is failing to change their spending habits. Just because you’ve consolidated your debts into one monthly payment doesn’t mean you can continue spending as you did before. Otherwise, you’ll just find yourself back in debt again down the road.
Evaluate why your business is in a situation where consolidation may be necessary. Is there extraneous spending? Excess staff? Do a real evaluation to discover the places where your company is spending outside its means in order to avoid having to consolidate debts in the future.
How to Improve Your Credit Score (so you can qualify for better terms on a consolidation loan)
If you’ve got bad credit, you’re going to face shorter repayment terms, higher annual percentage rates (APRs), and smaller loan amounts. If it’s possible to be patient on consolidating your loans, you may find that the extra time can be spent building up your business’s credit score in order to receive an even lower rate on your consolidation loan. What factors make up a business credit score?
Debt payment history
The traditional banks and online lenders evaluating your loan applications want to see that your business has a history of paying off your debts. Make sure you’re not missing any payments or making payments late, as these issues will show up in your credit report and hurt your business credit score.
This is the area where a consolidation loan can generate some angst for credit inquiries. For lenders, a business that has a lot of fresh debt is a business showing signs of financial trouble. Businesses with financial troubles are businesses that may struggle to pay their debts. If any of the debts you’re looking to consolidate are very new, you may want to consider waiting a while before consolidating.
Total debt and debt usage
If your company is already carrying multiple small business loans, you may have an excessive amount of total debt. If that’s the case, it may have a serious impact on your credit score. When you’re looking to consolidate, it’s wise to lower your total debt amount as much as possible and, in particular, pay down any lines of credit or credit cards.
In lenders’ eyes, some industries are simply riskier than others. For example, cannabis companies have to deal with ever-changing laws around their product, while restaurants are more likely than other companies to go under. On the other hand, a dentist’s officer is a safe bet. Operating in one of these risky industries has an impact on your credit.
If you’re a large company with lots of employees, lenders may view you as less likely to go under. A sole proprietorship, on the other hand, is seen as a riskier bet.