A small-business debt consolidation loan can reduce loan interest rates, cut the number of monthly payments, lower monthly debt service costs and provide superior terms.
Not surprisingly, many small-business owners analyzing the pros and cons of a business debt consolidation loan decide it makes good financial sense. More than one in four (27 percent) of 2,952 small firms that were surveyed for a 2019 Federal Reserve report were seeking financing to refinance existing debt.
Here are four situations when refinancing with a small-business debt consolidation loan can be helpful.
1. Lower Interest Rate
One of the biggest potential pluses of a business debt consolidation loan is the opportunity to lower interest rates on outstanding debt.
“If a business owner has one or several loans at higher interest rates they can get substantial savings by consolidating those higher interest loans into a lower interest rate," says Michael Taggart, the Granada Hills, California-based author of Goodbye Debt, Hello Future and co-founder of DebtReliefCenter.org. “The lower interest rate of a single loan can then speed up their ability to completely get rid of the debt.
“A consolidation loan can give a bit of breathing room and help a business owner get more aggressive in paying down their debt," Taggart adds. “In this situation, I would recommend a business owner look into consolidation loan options."
Turning many loan payments into a single fixed monthly payment on a business debt consolidation loan can help simplify a business owner's life. This is more than a mere convenience. It can mean saving time by writing fewer monthly checks and incurring fewer late fees for errors.
A related benefit is the opportunity to convert personal debt into business debt. Many business owners use personal credit cards to fund a business in the early years, notes Gerri Detweiler, education director for Draper, Utah-based small-business finance marketplace Nav.
“Now the business is doing well and you want to move to business credit," Detweiler says. “You could consolidate some personal loans and credit cards with a business loan."
One advantage of this move is the potential to boost the business owner's personal credit score if the personal debt has been affecting his or her personal credit score, Detweiler adds.
3. Lower Monthly Payment
Turning a number of loans into a single loan may mean having a single monthly payment that is lower than the combined payments on the previous debts. That can significantly improve a business's cash flow.
Debt consolidation loans allow businesses to convert short-term debt into longer-term debt, Detweiler notes.
“Entrepreneurs often have short-term financing when really what they need is long-term capital," she says.
4. Reduce Collateralization
Terms with some types of short-term business financing may let the lender place a lien on some of the business's assets, Detweiler says. This can restrict a business's ability to obtain future financing.
If the debt owed by the business is mostly unsecured, then you could be putting your business at risk by converting that unsecured debt to a secured debt that is collateralized.
—Michael Taggart, co-founder, DebtReliefCenter.org
A consolidation loan, on the other hand, can let a business refinance under more favorable terms.
“You might be able to consolidate debt to something that doesn't have such heavy collateral requirement," Detweiler says. That can help increase financial flexibility and make a business more attractive to other sources of capital.
Limits of Loan Consolidation
Not every analysis of a business' finances will arrive at a positive answer to the question of: “Is debt consolidation worth it?" A business owner who wants to preserve future financial flexibility, for instance, might want to be cautious about refinancing with a consolidation loan that doesn't have such a heavy collateral requirement.
“If the debt owed by the business is mostly unsecured, then you could be putting your business at risk by converting that unsecured debt to a secured debt that is collateralized," Taggart says. “Unsecured debt can usually be negotiated with lenders successfully as they, most likely, get nothing in the event of a bankruptcy. However, if you have to put up real estate, equity or other assets against the consolidation loan, you could lose those if you fail to pay off the debt according to the terms."
Another consolidation loan red flag might be a term that lets the lender call the loan at any time.
“This means you would have a short period of time to pay off the entire loan," Taggart says. “For many small businesses this can be an insurmountable hurdle as they are left to try to borrow more money, at a likely higher interest rate, to pay off the loan they recently got."
Many business owners considering whether or not to get a debt consolidation loan will decide it represents an appealing opportunity. And in the future, Taggart expects, debt consolidation loans will be an increasingly common approach to business capitalization.
“Lenders and borrowers can now meet online and there are more and more loan types being offered to borrowers every day," Taggart says. “I believe that we will see a continued rise in loans due to the efficiencies provided by our new digital world."
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