Many businesses borrow when they first start or are trying to grow. Others rely on loans when they face obstacles such as seasonal downturns or recessions. But structuring a business loan on a one-off basis can result in the business ending up with several different types of outstanding debt, each with its own interest rates and terms.
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What is Debt Consolidation? How do business owners use it?
Debt consolidation is the process of combining multiple outstanding loans into one new loan. Business owners use debt consolidation to lower the overall interest rate, extend the maturity of the loan, simplify the repayment schedule, or free up other forms of credit to finance ongoing business operations.
Debt Consolidation Options
There are many ways to consolidate business debt. Some lenders specialize in consolidation loans, but in fact, any loan that helps business owners reduce their outstanding debt will achieve the goal of consolidation. However, there are some types of financing that are usually better than others when it comes to debt consolidation.
Best Loans for Debt Consolidation
|Loan type||Best for|
|Bank loan||Borrowers with good credit history and reliable income|
|SBA loan||Low rates if you don’t have star credit|
|Fast financing for debt consolidation at high interest rates|
|Personal loan||Borrowers with strong personal loan and external collateral|
|Credit line||Getting regular access to revolving loans|
Not all of these loans are suitable for all business owners. In other cases, loans may be available but may not be suitable for your circumstances. So, the first thing you need to do is understand your options.
1. Bank loan
For businesses that have outstanding loans that they want to consolidate, the first choice should be loans from commercial banks. A term business loan is the most common type of financing used for this purpose. The biggest advantage of using banks for debt consolidation is their simplicity: they offer simple loans with simple conditions, simple underwriting and simple rates and commissions.
Although bank loans offer many benefits, they can be extremely difficult to obtain. Banks tend to look for established companies for lending, so you must have a well-established banking relationship, a strong credit history, and a stable income from the business if you choose to take this option. If you do not have a good credit history or your business is just starting, it may not be possible to obtain these loans.
2. SBA loan
The Small Business Administration (SBA) loan is issued by an SBA approved lender and then partially guaranteed by the SBA. IN SBA 7 (a) is the most common program used for consolidation purposes. The SBA approval stamp offers many borrowers access to lower rates than they might otherwise have received, and borrowers can usually claim lower credit scores than are required for a regular bank loan.
While an SBA loan can help you get a loan if you don’t have a good credit history, the SBA is not meant to be your choice in the first place. Instead, the SBA is the lender of last resort, so you should not consider using one of its loan programs if you have not already sought funding elsewhere. You will also need a solid business plan to qualify for an SBA loan, so make sure you have a plan ready before applying.
3. Alternative lending
Apart from conventional lenders such as banks and the SBA, there are also online lenders offering private loans… A term loan is usually the best type of alternative loan for debt consolidation. These loans are usually very quick and easy to obtain – business owners can often get approval within 24 hours and get financing within days.
The downside is that alternative loans are usually expensive. Aside from the high rates, most lenders require a business to run for at least a year or two in order to qualify. Alternative loans are probably your best bet if you need to get financing quickly, but if you have other options, you should definitely look into them first.
4. Personal loan
Personal business loans are great because you can get them using only your personal loan – you don’t need to have a business credit rating or a certain number of years in business to qualify. And these loans are often available online and offer quick approval.
However, in order to obtain a loan, you may need income that is not related to your business. The lender guarantees your loan based on your personal finances and credit, so the proceeds from your business may not count towards your application.
So, if you have external income or collateral separate from your company, a personal loan can be a great way to consolidate your business’s debt. It may also be your best bet if your company is still in its first or two-year phase of operations and you need quick funding, or if the debt you want to consolidate consists of personal credit cards and other personal debts that you used to financing their business.
5. Credit line
Lines of credit come in many forms. there is lines of credit, home equity lines of credit (HELOC) and even lines of credit available through the SBA. By using a line of credit, you get access to funds that you can use as needed. You only pay interest on the funds as you use them, and payments are usually only made on interest until the loan expires. Rates usually start at around prime plus 2.0%, but can be much higher.
One great thing about a line of credit is that once you pay off the money you borrowed, you can use it again. This makes a line of credit a great option if you need regular access to capital. If you only need upfront capital to pay off other debts, you can probably find lower rates with urgent bank or SBA loans.
How corporate debt consolidation works
The corporate debt consolidation process is not always straightforward, but it is quite straightforward. To consolidate debt, you need to take an inventory of your current debts. You will then need to find a lender and a loan product, apply, get approval, and use the proceeds from the loan to pay off your current loans.
When you get a consolidation loan, you probably won’t be able to get more than the total amount of loans you are trying to consolidate. In fact, you may need to make a down payment. Some lenders will also require a credit rating of 700 or higher, while others (such as SBA loans) may provide loans to borrowers with a credit rating of 640 or higher.
Business owners may also be unable to consolidate if they defaulted on any of their outstanding loans, if they had a recent bankruptcy, or if they have not been in business for at least a year or two.
8 steps to consolidate corporate debt
To get a consolidated loan, you need to follow several steps. A consolidation loan, like any other loan, will require application, underwriting and financing. The whole process from start to finish looks something like this:
- Take an inventory of all your outstanding loans.
- Calculate your total monthly payments and your effective interest rate (multiply the interest rate on each loan by the loan amount, then add the results and divide by the total outstanding debt).
- Determine if you can reduce the total cost of debt (for example, if your effective interest rate is higher than 8-10%).
- Find a lender who offers loans to consolidate your industry.
- Confirm that you meet the requirements – that your debt-to-income ratio will not exceed the lender’s limits, for example, after you have paid off outstanding debts.
- Apply for a loan and provide all supporting documents to facilitate underwriting.
- Close your loan.
- Pay off other debts and start paying off your new loan.
Items to collect before applying for a consolidation loan
Before applying for a loan, it is a good idea to prepare the paperwork. Debt consolidation loans are taken for a very specific purpose and it is important for your lender to know in advance why you want the loan and how you will use it. Otherwise, your loan application may be rejected because you already have outstanding debt.
So what kind of records do you need to organize in order to get a consolidated loan? Here’s what you need:
- Your business credit rating
- Your personal credit score (at least do a free check to make sure your credit is in good shape)
- Balance your personal finances
- Individual tax returns for the last two years
- Enterprise balance sheet and profit and loss
- Consolidated debt information
For each consolidated loan, you must include the lender’s name, your balance sheet, loan terms, interest rate, payment schedule, monthly payment amount, and any other relevant information. [Read related article: The Ultimate Guide on How to Get a Business Loan]
Business Debt Consolidation vs. Refinancing
Refinancing is when a borrower takes out a new loan and uses the proceeds to pay off the previous loan. This is usually done to lower the interest rate or extend the loan term for lower payments. This differs from debt consolidation in that refinancing is done for a single loan, while debt consolidation involves creating new financing to pay off multiple outstanding debts.
Most of the ways to consolidate corporate debt involve refinancing. But while refinancing is one way to consolidate corporate debt, it is not the only way – for example, borrowers can sell stock in their business and use cash to pay off the debt.
While not all refinancing options are for consolidation, getting a corporate debt consolidation loan is a lot like refinancing in that it requires applying for a loan, underwriting (including credit checks), closing, etc.
A consolidation loan can also have the same impact on a business owner’s loan as refinancing. The tough credit check will still be done and the loan will be added to your credit report as a new open credit account. And, if you can’t pay off all your debts with a new consolidated loan, you can actually hurt your credit rating if your overall loan utilization rises or you miss out on any payments. [Read related article: What to Know Before You Refinance Your Business Loans]
Pros and cons of business debt consolidation
As with any loan, a corporate debt consolidation loan has its pros and cons, so you should carefully consider your options and consult with your accountant or other trusted advisor. Here are a few points to consider before you decide that corporate debt consolidation is the right course of action for your company.
- You can often lower the overall interest rate.
- You will receive simplified repayment terms.
- No more credit juggling.
- There are several firms that specialize in this.
- Getting a loan can be difficult.
- Your overall interest rate can actually go up.
- You may end up paying more in the total interest over the life of the loan.
- Getting a loan without a down payment can be difficult.
- Debt repayment may take longer.