If your business is paying a daily merchant cash advance and you have a credit card balance, taking out a debt consolidation loan seems like a no-brainer: one loan and one monthly payment. Roll it all together and your problems will be solved. But is that really true? Many business owners don’t like keeping track of multiple payments. Consolidation simplifies your payments. But whether it saves you money is another matter entirely: it depends on much more than the interest rate you’re quoted.
The True Cost of a Loan
Start with this: the actual cost of any loan is often higher than the interest rate in the letter offer you received. This is because the interest rate and APR (annual percentage rate) are not the same thing. The interest rate on a loan does not tell the whole story about the cost of the loan. APR is a more accurate measure of the real cost of the loan. You can think of an APR as the true cost of a loan, because it accounts for not just the loan’s interest rate but other costs such as origination fees. When you run the numbers, you might find that a loan with a lower interest rate isn’t really the best choice.
Origination fees are where a lot of borrowers get caught. An origination fee is a cost to the borrower to get the loan - like a lender charging a fee for processing the loan. It’s usually a percentage of the loan amount, and some lenders charge anywhere from 0.05% to 10%, especially if your credit is weak. On a consolidation loan that matters, because not all of your loan goes to pay off debt - some goes to the fee. For example, if you took out a $10,000 loan and the origination fee was 5%, you’d end up with just $9,500 to pay off debt - the original loan amount minus the fee. A higher credit score usually means a lower APR.
Some borrowers say they were blindsided by hidden fees they found out about only after they signed the loan agreement. A prepayment penalty is a fee you’ll pay if you pay the loan off before the scheduled term. Some consolidation loans charge this. If you plan to pay the loan off early, be sure to ask about this fee and find out how much it’ll cost. Late fees are another. An administrative fee is a charge for the cost of processing and maintaining a loan. It’s a fee that may be levied on a monthly basis, so it’s important to keep track of any “recurring fees.” Read the agreement for all of them. If your consolidation loan cost more than the debt it pays off, then you just swapped one set of fees and interest for another. Not great news if your business needed the extra cash flow.
The second big factor is your repayment term. Longer terms mean lower monthly payments which makes budgeting easier. But it comes at a price. Extend the loan and you end up paying more in interest over the life of the loan. It’s tempting to go with the lowest monthly payment, and that’s perfectly reasonable, if the ultimate cost of the loan is manageable. If you have the cash flow to pay off a loan in a shorter term, you will save money on the total cost of the loan. Stretch it out and it’s cheaper in the short term but more expensive in the long term.
Qualify for a Consolidation Loan
So who actually gets the cheap money? You’ll likely need to show a minimum of one year in business, a personal credit score of 670 or higher and at least $50,000 in annual revenue in order to qualify for a consolidation loan. Traditional institutions like banks, credit unions and SBA lenders generally offer the lowest rates, but businesses that are newer or have lower credit scores may need to turn to online or alternative lenders. There, you’ll also pay more for the privilege if your finances aren’t in good shape. The truth is, the more qualified you are, the better rate you’ll get. It’s a good idea to shop for a consolidation loan to see what rate you’d qualify for and whether the savings would be worth the hassle.
Consolidation does the most good if you’re replacing a merchant cash advance or another type of short-term loan that has a daily or weekly payback. Moving to a monthly payment on an installment basis changes the game. It smooths out the cash flow, makes it easier to predict what you can spend, and it can bring a lower APR along with a lower payment. If it makes financial sense, consolidation is a good idea. If not, it’s not. Find out the total cost of the loan and make sure the interest and fees are worth the convenience.
Taking out a consolidation loan doesn’t lower the total amount you owe. It only shifts the debt to a different lender. If your debt is too much, consolidation only gives you more breathing room. Nearly every type of business loan will ask you to sign a personal guarantee, and for an SBA loan you might need to put up a significant down payment. That guarantee means if you can’t pay back the loan, you’re going to have to pay with your personal money. Don’t even sign it with a “yeah whatever” attitude. It will come back to haunt you.
Doing Your Homework
Before you apply, make sure you know the total amount to pay off each debt; add those amounts together to find out how much you need. Then compare the interest rates and APRs. Check the origination fees and any other fees that will be charged. Figure the cost of the loan over the entire loan term and see how it compares to the cost of your current debt. If the new payment is more than you’d pay separately to each lender, it might not be worth it. Make sure you can afford the monthly payment.
A business loan isn’t the only option for consolidation. If you own your home and have at least 20% equity, a home equity loan or HELOC could be cheaper than a business loan or credit card. But your home is on the line. If the loan goes bad, you lose your house. If that sounds scary, it should. Personal loans aren’t dependent on business revenue or how long the business has been operating, making them available to newer businesses. A rollover for business startups (ROBS) allows your business to use retirement funds without penalty, but your business must be a C Corp, and it can result in large fines if done wrong. What’s the risk? What’s the reward? Not a question every business owner wants to answer.
If you get denied, go back and double-check everything you put on your application for mistakes, ask the lender for specific reasons you were rejected, and fix that weakness before you apply again. Otherwise you may not get the lower interest rates and terms you deserve if your financials aren’t up to speed. There is no substitute for doing your homework.
So what does a business debt consolidation loan really cost? The interest, plus origination fees of up to 10%, plus whatever prepayment, late and admin fees are buried in the agreement, multiplied over however many years you stretch it, with your personal assets standing behind it. In the end, consolidation isn’t a magic wand. A business loan is an investment. One that can pay dividends in cash flow stability, interest savings or credit score improvement. But it’s an investment that comes with a price, and it’s not something you should take lightly. Do the math, calculate the true costs and interest, and yes, take the low payment if it makes sense. If you do, don’t pay more than you have to.
