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When Does Debt Consolidation Make Sense for a Small Business?

As a small business owner, you may find yourself juggling multiple debts – business loans, credit cards, equipment financing, and more. While some debt is normal, having too many different payments to make each month can become unmanageable. That’s where a debt consolidation loan can help.

What is debt consolidation?

Debt consolidation simply means taking out one new loan to pay off multiple existing debts. This new consolidation loan replaces all those other payments and gives you just one monthly payment to worry about.

The goal is to make repaying your debts simpler and more affordable. With debt consolidation, you may be able to get a lower interest rate, secure better terms, or get more manageable monthly payments.

When does debt consolidation make the most sense?

Consolidating your business debts can be a smart financial move, but the benefits depend on your specific situation. Here are some times when debt consolidation tends to make good sense:

You’re struggling with high-interest debt

If you have high-interest debts like credit cards or short-term loans, a consolidation loan can help. By refinancing this expensive debt into a new loan with a lower rate, you can save substantially on interest charges. This frees up cash flow to put back into your business.

For example, if you have $50,000 in credit card balances charging 25% interest, a consolidation loan at 10% interest could slash your monthly payments and save you thousands in interest fees over time.

You need to simplify unwieldy finances

When you have a lot of separate debts with different payment dates, amounts, and terms, it can be a headache to keep track of it all. If you find yourself missing payments, paying late fees, or just feeling overwhelmed, consolidation can simplify your finances.

Combining everything into one predictable loan with one due date and one payment amount can make your financial life much easier.

You want to improve cash flow

Multiple debts with high monthly payments can tie up your available cash. This leaves less money available to cover operating expenses, invest in growth, or take advantage of opportunities.

Consolidating your debts – especially high-interest, short-term debts – can free up cash flow by lowering your overall monthly payments. You can then put that extra money back into your business operations.

You need working capital

In addition to refinancing existing debts, some lenders will let you wrap in extra financing above what you owe. This gives you access to working capital that you can use to grow your business.

Just make sure you have a solid plan to put the money to good use and pay back the larger loan amount. Don’t take on unnecessary debt.

You’ve missed payments

If you’ve missed payments, racked up late fees, or defaulted on any accounts, this can hurt your business credit scores. Many lenders see consolidation as a “restart” – they pay off your problem debts and give you a fresh start with a new affordable loan.

Just be sure to only work with reputable lenders to avoid predatory lending practices.

How does the debt consolidation process work?

Here are the basic steps to get a consolidation loan for your business:

  • Review your finances – Make a list of all your current debts, interest rates, monthly payments, and terms. This helps you determine if consolidation makes sense.
  • Check your credit – Getting a consolidation loan requires good business credit. Check your scores and reports for any issues you need to address first.
  • Choose a lender – Shop around with online lenders, banks, and credit unions to compare loan offers. Look for the best rates, terms, fees, and qualifications.
  • Apply for the loan – The lender will review your application and request documents to verify your finances and collateral. This may include tax returns, bank statements, profit/loss statements, and business valuation.
  • Get approved – If approved, you’ll get a loan offer specifying the amount, rates, terms, and fees. Make sure you understand the offer before accepting.
  • Close the loan – After accepting the offer, the lender will finalize the paperwork. They disburse the loan funds to pay off your old debts and any extra cash to you.
  • Make payments – You’re now making one monthly payment to your new lender. Be sure to make all payments on time going forward to keep your improved finances on track.

What do you need to qualify for a small business debt consolidation loan?

Lenders have specific requirements you’ll need to meet to get approved for a consolidation loan:

  • Good credit – Most lenders require a minimum credit score around 650-680. The better your scores, the better loan terms you can qualify for.
  • Time in business – Expect to show at least 1-2 years in business. Some lenders may require more.
  • Revenue/cash flow – You’ll need to demonstrate your business makes enough money to comfortably handle the new loan payment. Annual revenue requirements vary by lender.
  • Collateral – Collateral like real estate, equipment, or investments may be required to secure the loan. Not all lenders require collateral though.
  • Tax returns – Multiple years of business tax returns are usually required to document your financial performance.
  • Proper business licenses – You must have all required state and local licenses and registrations.

As long as you meet the lender’s requirements, have a solid business, and provide all requested documentation, you should have a good chance of approval.

What are the pros and cons of small business debt consolidation loans?

Pros Cons
Lower monthly payments Closing costs and fees
Lower interest rate Larger total repayment
One easy payment Potential prepayment penalties
More cash flow Collateral may be required
Access to working capital Need strong credit and finances
May improve credit Still have ongoing debt
Get out of high payments/debt Risk taking on too much debt

What are the alternatives to debt consolidation?

While consolidation can be a smart financial move for many small businesses, it’s not your only option. Here are a few other strategies to consider:

  • Debt snowball – Focus on paying off your highest-interest debts first while making minimums on the others. Once the first debt is paid off, roll that payment amount into the next debt, and so on. This saves on interest charges.
  • Balance transfer card – Transfer high-interest credit card balances to a new 0% intro APR card. This pause on interest charges lets you pay down the balances faster.
  • Debt management plan – Work with a credit counseling agency to negotiate lower interest rates or payments with your creditors. They distribute one monthly payment to your creditors.
  • Debt settlement – Hire a company to negotiate debt reductions from creditors in exchange for lump sum settlements. This can impact your credit badly if not done carefully.
  • Bankruptcy – Legal bankruptcy filing wipes out many debts entirely, but severely damages business credit. It should only be a last resort option.

The bottom line

Debt consolidation can be a helpful tool for small businesses struggling with unwieldy finances, high payments, or cash flow issues. But make sure you take a holistic look at your overall financial situation first.

Consolidation treats the symptom more than the underlying problem. You need to address what got you into debt in the first place and make operational changes to shore up profitability.

Work with a financial advisor and explore all your options. Be wary of simply taking on more debt you can’t truly afford. With the right business strategy and discipline, you can get your finances back on track.

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