How Business Debt Consolidation Works

Business debt consolidation combines all your loans into one, which can lower your interest rate and decrease your risk of accidentally missing a payment. However, debt consolidation isn't for everyone. Before you combine your loans, learn how debt consolidation works and its benefits and risks.

How does business debt consolidation work?

Business debt consolidation is similar to personal debt consolidation. By consolidating all your business loans into a single loan, you will have one payment and may be able to decrease your interest rate, making your debt easier to manage.

Who should consider business debt consolidation?

Consolidation is recommended for business owners who feel overwhelmed with making payments to multiple creditors every month. Having to worry about only a single payment can help you budget expenses, making you less likely to miss a payment, which could hurt your credit score.

When consolidating loans, consider the amount of debt relief you need, because the loan should cover all your debts. For instance, if you're approved for a consolidation loan for $10,000 but you have $25,000 in debt, it won't make sense to consolidate. 

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Does debt consolidation hurt your credit?

Consolidating your debt can lower your monthly loan payments, but it can also cause a temporary dip in your business credit score. When you apply for a debt consolidation loan, the lender will make a hard inquiry on your credit, lowering your credit score by a few points.

However, if you pay your bills on time, you should regain the credit score points quickly. If you need to lower your annual percentage rate (APR) and monthly bills, a temporary dip in your credit score is worth the long-term goal of improving your finances.

Consolidating your debt into one loan may also help you get approved for future loans. When lenders look at your credit history, they don't like to see a list of various loans. If you think you might need an additional loan soon to support growth or sustainability, business debt consolidation can help you clean up your credit report.

What is the difference between debt consolidation and a loan?

Since debt consolidation is one of the many ways you can use a business loan, there is virtually no difference between the two.

A debt consolidation loan is a business loan you've designated for paying off other high-interest debts. By using the loan to pay off your existing business debt, including credit card balances, you simplify your finances, replacing multiple payments with one fixed monthly payment. 

Still, there are minor differences between business debt consolidation and a loan. Here's a summary.

When should you consolidate business debt?

If you have good credit and a moderate amount of debt, consolidating your business loans can save you money in interest over the long term. It can also streamline your monthly payments so that you have only one payment each month.

Before consolidating, make an honest report of your finances. Determine what debt payment you can comfortably make every month with your current cash flow. Look at your monthly financial obligations, and see where you can afford to cut business costs.

Consolidating business debt is effective only if you change your spending habits. By recognizing your spending triggers and seeking financial advice from your accountant, you can save your business from running into the red.

Bottom line: Business debt consolidation can't fix poor spending habits. Don't use it in place of smarter planning.

When is it a good idea to consolidate debt?

It's wise to consolidate debt when you're feeling overwhelmed with tracking multiple payments, but there are other excellent reasons to pursue debt consolidation.

• Lower interest rate: If your debts have high APRs, such as those on business credit cards, which can be 20% or more, but you qualify for a business loan with a low APR – such as from a traditional bank – you may be able to save money on interest. 
  
  
• Shorter loan repayment terms: You may also benefit from business debt consolidation if you want to shorten your loan repayment term. The shorter the period during which you repay your loans, the less interest you pay. And the less interest you pay, the greater your cash flow will be.
  
  
• Last resort: Although business debt consolidation is beneficial, it isn't a substitute for smarter spending decisions. You should spend only the money you know you have, which means investing in loans you know you can repay. As such, debt consolidation isn't a strategy; it's a last resort.

Here are some good and bad uses of business debt consolidation:

How many times can you consolidate business debt?

While you can technically consolidate your business debt multiple times, the consolidation process isn't the hard part. Recognizing that you have an overspending issue is the first step in getting a handle on your debt.

Using any form of debt consolidation to bandage a larger debt so you can continue to spend won't solve any problems. If you don't reflect on how you accumulated your debt, you will fall back into the same habits and potentially get into a financial hole you can't climb out of.

You can get back on track by creating a budget, tracking your spending and mentally preparing for any spending hiccups. Once you pay off your debt in full, consider depositing the money you were previously paying on your loan into a business savings account. You can then use that account to pay for unexpected expenses upfront, saving you time and avoiding the fees of obtaining another loan.

Tip: When applying for a small business loan, make sure you understand your credit profile, prepare your financial statements, and research your lender thoroughly.

What are the risks of business debt consolidation?

As with any loan, you must carefully consider the costs and risks of debt consolidation. Here are eight factors to consider.

1. New loan fees: When you apply for a business debt consolidation loan, the lender can tack on fees for the application and approval process. These fees are often added to your original debt, increasing the monthly payment.
   
   
2. Extended loan term: Lowering your monthly payment tends to increase the number of months it will take to pay off the loan in full.
   
   
3. Interest rate qualifications: Finding a loan with a lower interest rate to consolidate your debt is possible only if you have good credit and minimal debt. Use a loan calculator to see if a small reduction in your interest rate will make a difference in the total amount you pay over time. If you are already a few years in, or you have bad credit or too much debt, there's a chance you won't save any money by consolidating your business loans.
   
   
4. Prepayment penalty: If you're planning to pay extra money each month on the principal of your loan to pay it off faster, check your loan agreement to verify that there's no prepayment penalty. Lenders add this clause to ensure they make the maximum amount of money in interest on your loan.
   
   
5. Consolidation scams: Consumers and business owners get scammed every year by debt consolidation lenders. Stay away from these companies. Instead, research DIY solutions, such as balance-transfer credit cards with no annual fee and business loans. You can often find these through your financial institution or online vendors. Always go with a company that you have researched and trust.
   
   
6. Collateral: Some banks require collateral, such as property or equipment, to approve a business debt consolidation loan. If you haven't taken the time to analyze your spending and commit to a strict budget, you could easily fall back into excess spending. Are you prepared to lose what you need to put up for collateral?
   
   
7. Credit score: If your credit score has already taken a hit from your debt, you may not qualify for a debt consolidation loan – or, if you do, the interest might not be any better than what you are paying now. A good credit score is essential to secure the best business loans and financing options. Always aim to make your debt payments in full and on time.
   
   
8. More debt: Consolidating your debt may give you the illusion of having more money, especially if you are doing so to pay off business credit cards and thus have more credit available. Refrain from charging purchases on these cards to avoid the burden of paying back even more debt. 

Tip: To get the most out of your business credit cards, watch for introductory offers and terms, optimize card spending for benefits, and avoid accruing interest. 

Which fees are associated with debt consolidation?

Debt consolidation can take many forms, including traditional business loans from banks, SBA loans, alternative lending and business credit cards; some business owners even take out personal loans. No matter which you choose, though, small business loan fees are commonplace.

Consider all fees when deciding whether consolidation will help your business pay off its debts. Fee types and amounts vary by lender. Here are some fees to look for before accepting a loan:

• Application fee
• Origination fee
• Guarantee fee
• Appraisal fee (for collateral)
• Annual fee
• Late fee
• Prepayment penalty
• Closing costs

What qualifications do you need for business debt consolidation?

Lenders evaluate whether small business owners should be approved for business debt consolidation based on the following factors.

• Credit history and score: Like all business loans, debt consolidation requires a good credit history and credit score. That said, it's not the end of the road if your credit score or borrowing history is poor.
• Collateral: In some cases, putting up collateral can persuade a hesitant lender to approve your debt consolidation loan. Just be sure you can repay your debts so that your property isn't seized.
• Financial stability: If your financial statements show up-and-down revenue in recent times, lenders have no way to know that you'll earn enough to repay your loans, so approval is less likely.
• Business income: For obvious reasons, high business income is a much more straightforward route to loan approval than low income. Before consolidating your loans, you might want to work on boosting your revenue.

What are some business debt consolidation options?

This table offers a summary of leading debt consolidation options:

Tip: For more information about the lenders mentioned here, read our Fora Financial review, our review of SBG Funding, our Biz2Credit review, our Truist review and our review of Fundbox.

Is business debt consolidation right for your business?

When you face debt from multiple creditors, it can feel unbearable. In some instances, business debt consolidation may simplify your payments and reduce your interest rate. Carefully research your options to ensure a business debt consolidation loan is the best solution for your business.

Max Freedman contributed to the writing and research in this article.