Taking out a new business loan to pay off several existing debts is called debt consolidation. While there are many circumstances in which it can be a good option, there are also other situations in which it’s a bad idea. But in many cases, consolidation can help you by reducing your interest rate, your monthly payments, or both. It can also remove the ongoing hassle of monitoring multiple creditors.
There Are Downsides
Of course, borrowing does not magically resolve the problem - and so borrowing more is not necessarily a smart idea. There are downsides to doing a business debt consolidation loan. Applying for one can take a lot of time. You may need good business or personal credit to qualify. There is no guarantee that you’ll get better terms than you currently have. Lenders may charge fees. And the biggest mistake is speed. Rushing is what happens when you begin seeing cash flow problems, and so you start looking for ways to pay the bills. But quick money usually comes with a higher interest rate, and the last thing you want to do is acquire a new high-interest loan. So it’s important to be patient. Give yourself time to research lenders and meet with several of them, because you should not feel compelled to borrow money that comes with a higher interest rate if you can get a lower interest rate from another source.
Shopping for a Business Consolidation Loan
Before you go to a lender, add up how much debt you need to consolidate, and check four of your records to make sure you aren’t missing anything. Your accounting system shows the payments due on loans, credit cards and lines of credit. If you don’t have accounting software, grab a spreadsheet. Your balance sheet gives current balances, your profit and loss statement shows what you have paid in interest, and your cash flow shows how much leaves the bank each month to service debt. Include the interest rate and monthly payment associated with each debt. Check all of your balances and sum up the total amount of debt. Think of this as your starting line.
Next, look at your credit. You can consolidate with bad credit, but the terms will likely be less favorable than if you have a better credit rating. The better your credit, the more likely you are to find an affordable loan offer. If you apply for a business loan, a lender will look at both your business and personal credit. For sole proprietors and single-member LLCs, lenders check your personal credit report. You can get a free credit report from Experian, Equifax, and TransUnion once a week at AnnualCreditReport.com. Make sure everything on the report is correct. Business credit reports are harder to obtain. If you have a business EIN, you can pay Experian for a report, or you can sign up for a free account with Dun & Bradstreet Credit Insights for summaries and alerts.
When you’re shopping for a business consolidation loan, don’t focus just on rates, focus on service, too. An ideal lender will answer every question you have clearly and confidently. Does the company provide clear answers to your questions? Is it transparent about the rate, the term, and the fees? Are there surprises hiding in fine print? You should be able to learn the APR and how it is calculated (avoid daily interest rates), the application fee, any prepayment penalty, what it takes to qualify, and whether the lender’s license is current. If you can’t, that is a red flag. Can you trust a company that you can’t find information from? Get answers to all of your questions upfront. If you need between $5,000 and $250,000, consider looking at Community Development Financial Institutions (CDFIs) instead of banks. CDFIs are willing to do business with start-up and small businesses. They may also offer technical assistance with your loan.
Before you apply, gather your documents. That means a business plan, financial statements for the fiscal year and year-to-date, tax returns for the last 2-3 years, bank statements for the last six months, and statements for your existing loans, credit cards, and credit lines. The application can be lengthy, with lots of paperwork, and the underwriter may request additional documents. It can take a few days to a month or more to get your money once approved, and in the meantime you’ll have to keep paying your old debts. Some lenders will pay your creditors directly, but you need to ask and give them the account numbers. Otherwise, you’ll receive a lump sum transfer and you’ll have to divide it up among your various creditors.
Your Options
Consolidation isn’t the only way out, either. If you only have one of your business debts that is causing difficulty, you may be able to refinance that loan, replacing the existing loan with a new one that pays it off. This new loan could have a lower interest rate or a lower monthly payment than your existing loan. If a debt is weighing on you, give the creditor a call. Depending on the company’s policies, it may offer you a loan modification, deferred payments or other changed terms. Be forewarned, the interest on your debt may continue to accrue even if your request for deferred payments is approved.
So should you take another loan to pay off what you owe? Only if it truly gets you a lower rate, a smaller payment or fewer accounts, and only after you have shopped carefully. Before you consolidate, you need to be sure you know the cost, your options, and that you won’t take on more debt than you can handle.
