If your business is carrying a stack of loans, merchant cash advances and card balances, someone has probably offered to roll it all into one. Business loan consolidation is when a borrower combines existing credit into one new loan. One payment, one lender, maybe a lower rate. Yet debt consolidation services appear to promise the fast and easy relief you need, but they might not be the ideal solution after all. The first problem is the one lenders mention least. You’re not erasing debt. You’re swapping it. The original debt is still there, just in a new wrapper.
Then there is the term. Stretching payments from 12 months to 60 can lower your monthly bill - sometimes dramatically. But what you save each month costs you more in total interest. You may get a lower interest rate, but will you end up paying more money over the life of your loan? You could.
Fees are the next trap. In some cases, the lender may charge you an origination fee, anywhere from a super low 0.05% to a crazy high 10% of the loan amount - particularly if you are paying some subprime rates as a result of your credit. Lenders don’t always put that upfront. That fee raises the APR, which is why the APR, not the advertised interest rate, is the number to compare across offers. You might face origination, prepayment or other sneaky charges. Prepayment penalty means what it sounds like: an extra fee if you repay the loan early. Late fees and monthly administrative fees can sit in the same agreement. To stay out of trouble, make sure you read the fine print, all the fine print. Be sure you are completely comfortable with any fees that come up before you sign your contract.
Then comes the personal guarantee, which almost every business loan requires. This means that if your business can’t repay the debt, the lender can come after your personal assets. Plenty of owners sign anyway. They need the loan so badly that they voluntarily sign onto a responsibility that would ruin their personal finances if the company failed. Be honest with yourself. Even if you get your loan consolidation at a great rate, are you really sure you can take on more debt?
Just be aware that debt consolidation may hurt your credit. Over time, a record of on-time payments on the new loan may help your score, but it can drop before it gets better. And if the consolidation paid off a business credit card or line of credit, those limits are open again. You might not even realize that the credit limit is now open and it’s easy to rack up new balances on top of the loan you just took out. If you don’t change your spending habits, the consolidation will only help you delay your debt problems.
Harder to Qualify for a New Loan
Qualifying is a hurdle of its own. If you need consolidation, you likely have cash flow problems. Cash flow issues make it harder to qualify for a new loan. Lenders usually want at least a year in business, a personal credit score of 670 or higher and at least $50,000 in annual revenue, and because the new loan adds to what you already owe, they will check that your revenue and cash flow can carry the payment. Some lenders won’t let their funds be used to pay off other debts at all, and SBA loans may call for a hefty down payment. When you apply and get denied, you simply waste time. If you qualify, the new loan might come with a higher interest rate, which could actually cost you more.
The fallbacks can be riskier than the loan. Owners who are turned down sometimes borrow against their house. Those eligible for a home equity loan or HELOC have at least 20% equity in their home. If you have this equity, you can often get a lower interest rate on a home equity line of credit than on a business loan or a business credit card. However, if you can’t pay off the loan, the bank can foreclose on your home. You might risk losing your home in order to finance your business. Others look at a rollover for business startups, or ROBS, which lets a business tap retirement funds without penalty. It only works for a C Corp, it’s recommended to have at least $50,000 in the account, and doing it incorrectly can bring heavy fines.
Do the Math
When considering loan consolidation, it’s best to always start by asking: can I afford it? Get the payoff amount for each debt you want to roll in; the total is what you would have to borrow. Then try a loan consolidation calculator and see if the monthly payments come in under what you are currently paying. Then add up the total payments you will have to make and see if you’ll be saving in the long run. So do the math before you apply for a consolidation loan. Otherwise, you might end up costing yourself money.
If you were denied, don’t be in a rush to get that consolidation. Go back over what you submitted, because even small errors can sink an application, and ask the lender for the specific reasons, then work on that weakness before applying again. If you were approved, ask yourself a few more questions. Is the loan’s APR lower than your current rate? This is always the first question. Is there a prepayment penalty? You probably want the freedom to pay off the loan early and save on interest, so you’ll want to see no prepayment penalty attached to the loan. Make sure you understand what you are being asked to sign, and never sign something you don’t fully understand. The new payment might seem “manageable” but it could break your budget. If you still must borrow, at least make sure you understand the consequences.
