When you have multiple small business loans on the books at your company, it’s only natural to seek out ways to limit the interest you’re paying on each of them—especially if each of them comes with a different rate.
Add on the fact that you’ll be repaying most of your loans for different periods of time, and you have the incentive to find a way to make your debt a little easier to tackle.
When juggling multiple loans, business debt consolidation is a popular option. If you have multiple loans, you may be thinking about whether or not you should consolidate your business debt. However, if not done correctly, debt consolidation could end up costing you more in the long run than keeping your loans as they are.
Before consolidating, it’s important to understand how your debt will change and whether it’s the right move for your business and financial situation.
What does it mean to consolidate your business debt?
Before we get into the benefits of consolidating your business debt, let’s dive deeper into how debt consolidation works.
When you consolidate your business debt, you are essentially taking out a loan that pays off your other existing loans. Instead of paying each loan individually, you’ll pay a single creditor every month, with the new loan amount going toward paying off the preexisting money you’ve borrowed.
Business debt consolidation is offered through both traditional and non-traditional lenders.
Banks sometimes provide the best avenue for debt refinancing and, usually, offer lower interest rates than non-traditional lenders. Banks usually only lend to borrowers with ideal credit, though, so you may not get approved if your company’s credit history (or your own credit score) doesn’t look too hot.
Small business administration (SBA) loans are another great, affordable option for small business owners to consolidate debt.
While these loans are close to a bank product, they are different. SBA loan interest rates are slightly higher. Because the SBA partially guarantees a portion of the loan, lenders assume less risk and, hopefully, are able to lend to more small business owners.
Lastly, there are what the industry likes to call, “medium-term lenders,” such as Funding Circle or Lending Club that provide online term loans to business owners that come with a bit higher interest rates than bank or SBA loans and shorter repayment terms.
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When it makes sense to consolidate your business debt
Lower interest rates
If most of your business loans have high interest rates, there’s a chance business debt consolidation could lower your overall rate.
Consider timing your consolidation efforts with economic trends and interest rate levels. Financial professionals can help you with advice on whether or not certain economic indicators lean toward higher or lower interest rates on the horizon; if it looks like rates are set to be lower than what you’re currently paying, consolidation could create significant cost savings.
Streamlining your finances
Another great reason to consolidate your business debt comes down to organizing and streamlining your business finances.
Having several loans on your books can become a hassle and increases the possibility that you might forget to pay one of the loans on time (and, in turn, damage your credit). By putting your existing debts into one comprehensive loan, your payments become more predictable and harder to forget.
When you want a better payment schedule
Short-term business loans can offer quick access to cash, but often require daily or weekly repayments, which can make it tough for business owners to manage their cash flows. If you have a few short-term loans and find you payment schedule isn’t working, consolidating could possibly allow you to make monthly payments instead.
If your personal or business finances have improved
Say your company’s creditworthiness has improved, or your revenue has increased significantly since you took out your loans.
If that’s the case, debt consolidation can help you use your improving finances by providing you with a better interest rate or more amenable lending terms.
When consolidating your business debt doesn’t add up
When interest rates are high
As promising as it sounds to consolidate existing business debts into a single loan, there can be downsides to doing so that might end up costing you more money in the long-term.
While this might be stating the obvious, if your new loan has an even higher interest rate than your existing debts, there’s really no benefit for your pocketbook and this should be avoided.
When you’ve only been in business for a short time
The best time to pursue debt consolidation is after your company’s been in business for more than a year. Most business financing requires some time in business, along with decent credit and revenue.
If your business’s overall picture hasn’t really improved since you first took out business financing, you probably won’t qualify for a better term loan, and it may be a good idea to wait a little longer.
You have to pay prepayment fees
As you’re looking to consolidate your debt, the first thing you want to check is the cost of paying your current debt off early.
In some cases, usually on long-term, amortizing debt, you’ll be completely forgiven of any remaining interest. In other cases, there might be prepayment penalties. This could mean, to pay the loan off early, you have to pay a flat fee or a percent of the remaining interest still owed on the loan. There are even some cases when paying off your loan before it’s due means you’re still on the hook for all of that loan’s interest.
The reason it is important to know the prepayment terms for your current loans is that, if you have to pay all or some of the remaining interest on these loans, you’re essentially paying interest on interest. As you’ll take out a consolidation loan that has a principal large enough to repay all your outstanding debt, if there is a prepayment penalty, this means not only will you have to cover the amount borrowed, but also whatever fee, set percent, or remaining interest you’re accountable for.
This will make your principal for the consolidation loan larger than your current amounts borrowed, possibly saving your business less money than you might think, as interest is charged as a percent of loan amounts.
That being said, even if your current loans have prepayment penalties, it still might be cheaper to consolidate them all into a loan with better rates and longer terms.
This is absolutely the most important thing to explore if you’re considering consolidating debt. It is obviously very complex, so it’s a good idea to speak with loan specialist before you pursue debt consolidation.
If your company’s sales look strong, it has a healthy balance sheet, and your personal financial health is up to par, then trying to consolidate your business loans can be a great way to make repaying debt easier and, hopefully, less expensive.
Remember that any kind of financing is not without its potential pitfalls, consolidation loans included. Make sure you know your numbers inside and out before making the big financial step toward taking out another loan.
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Meredith Wood is the Editor-in-Chief at Fundera, an online marketplace for small-business loans that matches business owners with the best funding providers for their business. Specializing in financial advice for small-business owners, Meredith is a current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness, and more.