The Pros and Cons of Debt Consolidation
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Do you have business credit cards with outstanding balances? Are you also making payments on a short-term loan and a line of credit? If you’ve been struggling to manage multiple payments, a debt consolidation business loan could solve your problem.
Debt consolidation loans help small business owners who have opened multiple forms of credit. They can save you money, simplify your finances, and boost your credit score. But they have their downsides, too.
Read on for the pros and cons of debt consolidation.
What is Debt Consolidation?
Debt consolidation rolls multiple forms of debt into one loan product. A debt consolidation business loan pays off business credit cards, existing loans, and merchant cash advances, replacing them with one business loan. After a debt consolidation, a borrower only has one lender and one payment instead of many.
Ideally, debt consolidation simplifies budgeting and cash flow management, as well as saves you money.
Pros of Debt Consolidation
Why consolidate your debt? Here are five reasons it could be a good idea for your business.
Debt Consolidation Gives You One Monthly Payment
Is your credit card bill due on the 25th, or the 28th? What about the short-term loan payment, have you transferred money to cover the automatic withdrawal next week? If you have several forms of debt, consolidating them into one payment could make your life a lot easier.
When you’re managing multiple forms of debt, you’re also managing multiple payments. For many small business owners in this situation who are also trying to run their business, budgeting and cash flow management can become another full-time job. If you forget to mail a check or transfer funds, you’re hit with overdraft or late payment fees.
Debt consolidation replaces multiple daily, weekly, or monthly payments with one easy payment. It simplifies your finances, freeing you to focus on running your business.
Debt Consolidation Could Lower Your Interest Rate
A lowering interest rate will save you money and help you pay off the loan faster. Consolidating your debt could, depending on your credit score, net you a lower interest rate. If you’re paying 22% interest on your credit card and have a short-term loan with an interest rate of 15%, the interest rate on a new debt consolidation loan could be lower.
First, determine your blended interest rate. This is the rate you’re paying across all your debt, and it’s based on both the loan product’s rate and the outstanding balance. Compare this rate to the rate offered by the debt consolidation company to see if it’s lower.
Debt Consolidation Could Lower Monthly Debt Payments
If you qualify for a lower interest rate, that would also mean a lower payment.
If you currently have total debt of $10,000 with a combined APR of 22% and combined monthly payment of $518, in two years you’ll pay $2,450 in interest. Taking out a debt consolidation loan with a 17% APR and a two-year repayment term would save you $494 a month on your payment and $1,866 in interest. This is just a small example as you can multiply these number as you deal with larger debt payments and interestrates.
When you’re paying less overall for your debt, it frees up cash flow for working capital needs. It’s less likely you’ll need to borrow again in the future.
Debt Consolidation Could Help You Pay Off Your Debt Faster
If you’re sending less money to various lenders, and saving on interest, you might be able to pay off your debt faster.
When debt consolidation lowers your monthly payment, it puts money back in your pocket. During months that you don’t need to use those funds to cover working capital needs, send a little extra to your lender. If you can make payments above the minimum required payment, it shortens the time until you’re debt-free.
Debt Consolidation Can Build Your Credit
When you first apply for the debt consolidation loan, the lender will pull your credit. While this can temporarily drop your credit score by five points, in the long run taking out a debt consolidation loan can build your credit.
Debt consolidation lenders will report your new loan and payment history to credit bureaus. Making on-time payments in full boosts your credit, and can be particularly beneficial if you’ve struggled to pay old debt on-time. Paying off credit cards will lower your debt utilization ratio, also improving your score.
Over time, a debt consolidation loan could be a net positive for your credit score. A higher credit score will make it easier to borrow in the future, and you’ll pay lower rates on future borrowings.
Cons of Debt Consolidation
What are the downsides to a debt consolidation loan?
You Could Fail to Qualify for a Lower Rate
It’s not a guarantee that you’ll qualify for a lower interest rate when you apply for a debt consolidation loan. Your credit score may have dropped since you opened that credit score – particularly if you’ve since opened multiple forms of credit.
Paying a higher interest rate overall means that your debt will cost your business more. However, if the debt consolidation loan would still lower your monthly payments (which it could do if you extend the repayment term), and give you some needed room in your budget, it might still be worth it.
You Could Miss Payments
Before taking out a debt consolidation loan be sure that the new payment will fit your budget. It’s also not a guarantee that this loan will have lower payments than the debt it replaces.
The lender will report any missed payments to the credit bureaus, lowering your score. The repayment plan for your new loan product should comfortably fit within your budget over the loan’s term, otherwise you’ll be in a worse place than before you consolidated the debt.
You May Have to Pay Upfront Fees
Some debt consolidation lenders will charge upfront fees for the loan. These could include:
- Application fees
- Origination fees
- Balance transfer fees
- Closing costs
- Annual fees
These fees will increase the loan’s overall cost. Ask your lender about their fees and factor them into your cost-benefit analysis.
As well, some lenders charge prepayment penalties. Paying off the loan early would not save you any money in interest.
A Debt Consolidation Loan Doesn’t Fix Core Issues
Why did you fall into debt in the first place? It could have been due to poor money management, or losing tracking of your business expenses. Perhaps sales have dipped, or you failed to account for seasonality in your budget.
Whatever the reason that you began borrowing, unless you address those core issues, you’ll likely need to borrow again. A debt consolidation loan solves the current problem but not the issues that led to the borrowing. Failing to address those underlying issues could lead you to borrow again on top of the debt consolidation loan, further sinking your credit and harming your business.
Take a deeper look at your business and why you ended up in debt and come up with a plan to fix those problems. Otherwise, a debt consolidation loan could only contribute to your business’ downward spiral.
Should You Consolidate Your Debt?
After weighing the pros and cons of debt consolidation against your business’ circumstances, you still might be undecided if debt consolidation is right for you. Here are four questions to ask yourself to make the final determination.
1. Do you have a good credit score?
Borrowers with a high credit score will likely pay a lower interest rate on a debt consolidation loan.
2. Do you prefer fixed payments?
When preparing your budget, do you like to know the exact payment and due date? A debt consolidation loan could better fit that preference than credit card or other fluctuating payments.
3. Do you want just one monthly payment?
In addition to a fixed payment, do you only want to make one debt payment monthly? Has keeping track of multiple payments become an unwanted headache? A debt consolidation loan could be the aspirin you need.
4. Can you afford to repay the loan?
The loan only benefits your company if you can afford repaying it. If the loan fits within your company’s budget and projected cash flows, you’ll avoid sinking deeper into debt.
Is Debt Consolidation Right for Your Business?
While that’s a question only you can answer, the experts at Shield Funding can help. Reach out today to find out about loan rates and terms, and talk to them about your business’ debt profile or for further reading see the article on determining if debt consolidation is right for your business.