It can be difficult for small business owners to obtain capital. If you’ve only been in a business a few months, most lenders won’t approve your application. Any blips on your credit score? They toss it in the circular file.
Many small business owners have found that a merchant cash advance is a easy and quick way to obtain the funding they need. But merchant cash advances create their own problem. The daily withdrawals for payments can hurt your business’s cash flow and you find yourself in a constant cycle of taking out a new advance to make payments on the last advance.
If you’ve decided that it’s time to break this cycle, a reverse consolidation is one of many business loan products that helps small business owners consolidate and pay off MCAs. But before you apply for one, make sure you know the ins and outs of this tricky loan.
A merchant cash advance or MCA is an advance against future credit card sales. When you apply for a MCA, the lender asks to see your last several months of credit card statements. After analyzing it, they advance a lump sum based on their best estimates of your future credit card sales.
Lenders automatically deduct their repayment from each day’s credit card receipts. Many small business owners like how easy it is to repay a MCA, and how quick it is to apply for one. But it’s also easy to end up in a situation where you’ve over-extended yourself.
If credit card sales decline, or a major customer decides to pay by check this month, you could end up taking out another MCA to pay off the first one. Or, sometimes you just need more time to repay your MCA. Explore our guide to an mca for a larger overview of the product.
With multiple loan products available to help consolidate and manage existing debt, when would a reverse consolidation be your best option? When existing debt has prepayment penalties or unusually high rates and terms.
Lenders calculate their profit – the additional cost earned on your loan – when they make a decision to extend credit. To protect this profit, many lenders put prepayment penalties in their loans. Even if you paid off the MCA early, you’d have to pay the total interest plus possible fees.
If your merchant cash advances have prepayment penalties, you wouldn’t save any money by refinancing or consolidating the MCA’s and paying them off early. But there would be a benefit to reducing the number of payments you’re making weekly and freeing up cash flow. And that’s what a reverse consolidation does for your small business.
Like any lending product, there are pros and cons to reverse consolidations. A loan can have a huge impact on your business – whether negative or positive. If borrowing in haste in the past landed you in your current predicament, now is the time to slow down and think through the pros and cons to further borrowing.
On Monday, the reverse consolidation lender deposits $5,000 into your bank account. The merchant cash advance lenders take their withdrawals each day and you don’t have to worry about having enough to cover them – all you have to do is pay the reverse consolidation lender. If budgeting and cash flow has been an issue, this can be a huge weight off your shoulders.
A reverse consolidation frees you from cash flow concerns by ensuring you have the money to service your existing debt. It could also give you a little extra. If the reverse consolidation lender deposits $5,000, but your MCA payments are $3,000, you have an extra $2,000 to run your business.
Maybe you have a low personal credit score which is preventing you from qualifying for better terms or loan products. Or, you haven’t been in business long enough to qualify for a traditional loan. Reverse consolidations bridge the period between starting up your business and qualifying for better loans.
If your existing debt has prepayment penalties, you can feel stuck with payments that are hurting your business. With a reverse consolidation, you get some relief but avoid those penalties.
While a reverse consolidation may help you manage your debt better, it will not reduce it. It does not pay off any existing loans, it adds to them.
One of the ways that a reverse consolidation frees up cash is by extending your repayment term. In simple terms – if you owe $5,000 over five months, you’re repaying $1,000 of principal a month. But if you owe it over ten months, you’re repaying $500 a month and can use that $500 to run your business. But you’ll be making payments longer than anticipated.
In the above example, you’d also be paying interest for an additional five months. That adds to your total cost of debt. After you’ve paid off your merchant cash advances, you’ll still owe the reverse consolidation lender.
A reverse consolidation isn’t like a term loan, where the lender advances the loan’s total amount in one lump sum at the beginning of the loan period. Reverse consolidation lenders deposit that week’s funds one day a week. But if you default on the reverse consolidation’s terms at any point, you could owe for the entire loan even if the lender hasn’t advanced the money yet.
For example, you’ve borrowed $20,000 of the total $50,000 in your loan with the reverse consolidation lender. But your bank balance falls below the loan’s threshold two days this month and now you’re in default. The reverse consolidation lender can now claim you’re in default and sue you for the entire $50,000 (even though you never got $30,000 of it!) plus penalties.
With a short-term business loan, you can pay off all your merchant cash advances and only make one payment. While you might have to pay prepayment penalties on them, if your primary goal is to reduce your monthly debt servicing but avoid further financial difficulties, a short-term loan could be better for your business than a reverse consolidation.
Short-term business loans have terms of one to three years. This longer repayment period lowers your payments. Interest rates range from 9% to 45% and you can borrow between $15,000 to $750,000 to pay off existing debt.
While a reverse consolidation is a good option to avoid prepayment penalties, it’s a tricky loan product with a lot of downsides. Failing to meet the loan’s terms at any point could result in a default situation that costs you far more than the loan ever paid out.
A working capital loan can be used to provide additional working capital for the business while at the same time settling outstanding debt. The typical repayment term on a new working capital loan is anywhere from one to three years, with interest rates of 9% to 45%. You can borrow between $10,000 to $1 million with a fair credit score as low as 650.
You can also take out one, larger merchant cash advance and use the proceeds to pay off your multiple, smaller merchant cash advances. This consolidates them into one payment and extends the repayment term. Budgeting gets easier and you have more free cash flow.
The typical repayment term on a new merchant cash advance is anywhere from two to twelve months, with interest rates of 24% to 49%. You can borrow between $8,000 to $250,000 with a credit score as low as 500.
If the multiple merchant cash advances have lowered your credit score, banks and traditional lenders may no longer be willing to work with you. Applying for a bad credit business loan lets you consolidate your merchant cash advances and stops your credit score’s downward slide.
With a bad credit business loan, you can take out between $5,000 to $1 million for a two to eighteen month period. You’ll need minimum monthly revenues of $8,000 and a credit score above 500. Rates range from 12% to 45% and the lender takes their repayment by automatic debit from your banking accounts five times a month.
If your goal is to pay off multiple merchant cash advances and roll them into one, manageable payment, contact a loan officer today. A reverse consolidation is only one tool of many to get this done. They’ll look at your current situation and help you pick the best loan product for your small business’ success.
