Debt Consolidation Guide
Table of Contents
Whether you’re just starting out in business, or went through a lean period, it’s not uncommon for small business owners to carry multiple forms of debt.
To help with cash flow, you may have taken a working capital loan or merchant cash advance. Maybe you funded a remodel or expansion with a small business loan. No matter how it happened, now you have to keep track of different due dates, interest rates, and terms each month.
Debt consolidation can make your life easier, freeing you from bookkeeping headaches and giving you more time to run your business.
What is Debt Consolidation?
It is not uncommon for small business owners to have multiple forms of credit open. Whether it is a business line of credit, a small business loan, or some other type of loan that you may have stacked on another loan to launch a business or just keep it operating. At the time, you had valid reasons to borrow, but now that debt could be hurting your business.
This type of debt problem has grown exponentially with the economy struggling because of Covid-19. Many business owners took out a business loan or some other form of debt and started expanding their business right before the pandemic exploded. Others are currently dealing with the fallout and are struggling to deal with the various payments outstanding on their everyday operating debt.
Staying on top of multiple loan payments in one month can become mentally wearing, and pull your attention from your business. The interest rates and fees could now outweigh a business loan’s initial benefit. These factors could make you an excellent candidate for debt consolidation.
Overall, debt consolidation replaces all of your existing debt with one new loan. You’re taking out a new, larger loan to pay off other debt, replacing multiple payments and interest rates with one easy payment.
Is Debt Consolidation Worth it?
A debt consolidation should do three key things to be worthwhile.
It should cover all outstanding debt. If you owe $40,000, it makes no sense to take out a debt consolidation loan for $30,000. Make sure your new lender offers loans with maximums that will clear your current debt.
It should have a lower blended interest rate. The blended interest rate is the combined interest rate you’re paying on all debt. It’s calculated by comparing outstanding balances to their interest rates. Your new loan should have a lower interest rate than what you’re currently paying for debt.
It should make your life easier. While your new loan ideally has a lower interest rate and saves you money, you may just need to borrow to extend the repayment term and lower your payments (freeing up cash) or to reduce administrative burdens.
If a debt consolidation loan doesn’t accomplish at least one of these goals, re-think borrowing.
What is the difference between consolidating and refinancing my debt?
While they look similar, there are some differences between a consolidation and a refinance.
Refinancing: When you refinance, you take out a new loan to replace an existing loan. But it could be a one for one swap, with the new loan having a better interest rate and terms.
Consolidation: With consolidation, you’re replacing many types of debt with one loan. When the new loan funds, you pay off existing debt, and then only have to make one payment.
The key difference is whether or not you’re replacing one or many forms of debt, though you can manage them the same way.
Preparing to Consolidate Your Debt
Taking the time to prepare your application and documentation before approaching a lender will save you time and aggravation. Chances are, you need capital quickly and want to improve your financial situation sooner rather than later. Submitting incomplete documentation slows the loan approval process and leads to unnecessary delays.
Pull together all information about your current business debts. This should include your most recent statements with outstanding balances, interest rates, due dates, and the lender’s contact information. If you have not already, plug all of this information into a blended interest rate calculator.
A blended interest rate calculator tells you how much you are paying for all your debt combined, and knowing this rate will help you compare loan offers. It can inform your decision between multiple loan offers, or help you determine if the loan you are offered saves you money in interest or fees.
While gathering documents related to current debt, check for prepayment penalties. A prepayment penalty in a loan contract means that even if you pay the loan off early, you will pay some of the future interest. This additional lump sum payment to the lender reimburses them for the profit they will lose out on when they do not receive all your future payments.
Even if you must pay a prepayment penalty, a debt consolidation business loan could still be worthwhile. You could still pay less overall, or rolling that loan into a debt consolidation loan could ease your cash flow situation. But you should factor the cost of prepayment penalties into your calculations.
Something else you will want to know before contacting lenders is your credit score. The major credit bureaus must provide you with one credit report yearly, free of charge. Knowing what is on it, and your overall score, will tell you where you will likely be able to obtain funding.
Once you have all this information in hand, you are ready to approach lenders about debt consolidation. Depending on your credit score, you will have several options.
How to Get a Business Debt Consolidation Loan
If you’ve decided the time is now for a business debt consolidation loan, here’s how to get one.
Step 1: Gather all information on current debt.
As mentioned above, put together all of the information on your outstanding debt. This includes credit card statements, loan documents that you’ve signed, and any information on what you currently owe that may not be mentioned here. You need this amount, both to make sure you borrow enough to pay it all off and the overall consolidation makes sense for the bottom line, but also to have it ready for lender inquiries.
Step 2: Check your credit score.
If borrowing repeatedly has hurt your credit score, you want to know before you talk to a bank. Most traditional lenders won’t work with borrowers who have credit scores below 650, but you can still work with an alternative lender. Knowing your score saves you from wasting time with a lender who won’t approve your loan application.
Step 3: Talk to a lender.
With most lenders, you can apply online or over the phone. Set up a time to meet and discuss your business and financial situation. The loan agent can guide you to the best loan product, and give you a rough idea if their institution is likely to approve a loan.
Step 4: Submit required documentation.
Once you desire to proceed with a lender, submit an application and required document. With traditional banks this can include: two years of tax returns, audited financial statements, IRS filings, bank statements, lists of assets (and proof of ownership), and more. Alternative lenders make it much easier to borrow, requiring less documentation.
Step 5: Wait to hear back from underwriting (or not!).
Once you’ve submitted your documents, sit back and wait. And wait. Traditional banks can take two to three months to approve a loan. The underwriters may come back with more questions and requests for documentation, too.
Alternative lenders, on the other hand, can approve a loan in as little as 24 hours.
Step 6: Receive your funds!
Once a loan passes through underwriting and hopefully gets approved, it will close and the funds will be disbursed. With traditional lenders, this can take another few weeks, but alternative lenders can deposit the monies to your bank account within days.
Step 7: Pay off your debt
It needs to be said – make sure that you use the debt consolidation loan’s funds for their intended purpose. Once the money is in your account, it could be tempting to use it to pay for a new project or expansion, but it’s important to remember why you borrowed in the first place. If you fail to pay off your existing debt with the debt consolidation loan, you’ve just doubled your debt and put your business in a worse financial position.
Pros and Cons of Business Debt Consolidation
There are pros and cons to any borrowing decision. Before signing on the dotted line of your new loan, compare these pros and cons to your business’s circumstances and be sure you know how the new loan will impact your business.
Pros of debt consolidation
Improved cash flow. If your debt consolidation loan has a lower interest rate, it saves you money. Keeping that money in your business – instead of sending it to a lender – improves your cash flow. As well, if the new loan has an extended repayment term that will lower your monthly payment. A lower monthly payment also improves cash flow.
More manageable payments and accounting. Monthly bookkeeping will be easier – from bank account reconciliations to remembering to send loan payments. A loan consolidation simplifies keeping track of payments and outstanding debt.
Credit score boost. Managing your payments better – including not missing any payments – could boost your credit score.
Cons of debt consolidation
Debt consolidation doesn’t always lower your interest rate. It’s not a guarantee that a debt consolidation loan will have a lower interest rate. You may decide to borrow for the peace of mind and to free up cash flow due to lower monthly payments, but not save money on interest.
You could pay more interest over time. Extending the repayment term could lead to paying more interest on the debt over time.
It might not solve your cash flow issues. Sometimes borrowing covers up a deeper business problem. If your business continues to have cash flow issues, it might be time to re-evaluate other areas of sales and operations.
Existing debt could have prepayment penalties. When a lender extends credit, they count on making their profit (interest paid and fees). Many lenders want to protect their profit so they put prepayment penalties in their lending agreements.
The new loan could impact your credit score negatively. If your new loan has a higher balance than existing debt or changes your debt utilization ratio, it could negatively impact your score.
Best Options for Business Debt Consolidation
Small business owners have several options for business debt consolidation loans. One of these will best fit your circumstances.
1. Merchant Cash Advance
If your business does a large volume in credit card sales, you might want to apply for a merchant cash advance. With a merchant cash advance the lender calculates how much they’ll advance you on past credit card sales and you sell a percentage of those sales to them. You’ll need to provide your past few months bank statements and credit card receipts when you apply.
It’s an easy loan to repay since the lender takes their repayment from future credit card sales. It’s deducted from your cash flow in dollars and cents, not a large, monthly lump-sum loan payment. If you have minimum monthly revenues of $8,000 which are mainly processed through credit cards, you can apply for a merchant cash advance with a credit score as low as 500. One thing to note – a merchant cash advance can have interest rates than many other forms of debt.
2. Bad Credit Business Loans
Unfortunately, opening multiple forms of debt could have hurt your credit score. If your score has dropped below 650, traditional lenders may no longer be willing to work with you.
Alternative lenders extend bad credit business loans to borrowers with less than stellar credit or a rocky business history. While your credit score could disqualify you for bank financing, other factors such as time in business or number of open lines of credit can also lead to a loan application’s rejection. Banks are picky about lending and reject about the same number as loan applications as they approve, so you might go to an alternative lender for a reason other than your credit score.
Alternative lenders can approve loan applications within 24 hours and disburse funds in a few days. Shield Funding gives borrowers loans in amounts ranging from $5,000 to $1 million, at rates of 12% to 45%, for terms of two to eighteen months. As long as you have monthly revenues above $8,000 and a credit score above 500, you can qualify for financing with an alternative lender.
3. Short Term Business Loans
If you want to pay off your debt quickly, a short term loan might be best for meeting your needs.
A short term business loan has the same underwriting and approval costs for banks as a long-term loan, but because they make less money off short-term loans, banks are reluctant to lend for short terms. Alternative lenders offer short term business loans with terms of just six to twenty-four months at interest rates of 9% to 45%.
To apply for a short term loan at Shield Funding you must have been in business for a minimum of two years and need a credit score of at least 650. Your business’s minimum monthly revenues must exceed $10,000, but you can borrow as little as $15,000, and there are no prepayment penalties. If you know that you can pay off the loan quickly, a short term loan could be better for your business than another loan product.
Need more information? Ready to apply? Contact Shield Funding today!
Traditional Bank Loans for Debt Consolidation
Banks and traditional lenders will approve small business owners for debt consolidation loans if they qualify for funding. Traditional lenders rarely work with borrowers who have less than excellent credit scores. They also prefer that your business has been in operation for at least two years, and that you have low debt service ratios.
On average, it takes up to three months, for a bank to approve a loan. Expect to provide significant documentation with your application, such as bank statements, tax returns, business plans, financial statements, and more. If they require certified statements, you may have to pay an accountant to prepare them. If you cannot afford to wait for financing, a bank loan is not your best option. However, if you have time and can find a way to meet a bank’s requirements, banks usually offer the lowest interest rates and longer repayment terms than any other lender.
SBA Loans for Debt Consolidation
Small Business Administration loans exist to promote the success of small businesses in America. If you are approved for an SBA loan, the government guarantees a portion of it to the lender, which lowers their risk. Thus, banks will lend at a lower interest rate and to slightly-less qualified borrowers.
With the government guarantee, the lender does not demand as high of a credit score. There are, however, still fairly strict qualifications including time in business of two years and a credit score above 660. The approval process lasts just as long as a traditional bank loan, and there are restrictions on what you use the loan’s proceeds to fund.
It is important to note that traditional SBA loans are not the same as the Payment Protection Plan or PPP loans, or the EIDL disaster loans enacted through he CARES act. These are temporary programs that will likely run out at the end of 2020, but they have eased many requirements and even have portions of the money forgiven. Once those options are exhausted the SBA will still have great funding programs and they are really worth it as a debt consolidation option if you have the time and can meet the requirements.
A business loan for debt consolidation could be the smartest move you make to support your company’s continued operations and growth. Not only will you improve your debt management and possible lower your payments, it will help you build your credit history and make borrowing easier and cheaper in the future. If you have been considering consolidating your debt, talk to a Shield Funding business loan expert today.