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Grow Your Business Finances

How to Choose a Business Debt Consolidation Loan

image for Kerkez / Getty Images
Kerkez / Getty Images
  • Debt consolidation loans aren't bad if they help you lower your interest rate or free up your cash flow.
  • Options abound for small business owners who are seeking debt consolidation loans, but only those with strong financials and a good credit score are eligible for an SBA loan or a bank loan.
  • Alternative lenders may charge higher rates, but if you streamline your payment schedule, it may be worth it.
  • This article is for small business owners who need to consolidate debt but don't know which lender is right for them. 

Loans are a necessity for many small business owners, who use them to support cash flow or pay unexpected expenses. But for those with multiple debts, it can be difficult to manage all of the due dates and different payments – and that's where business debt consolidation comes in. With a debt consolidation loan, business owners can whittle their debt into a single monthly payment, often at a lower interest rate.

Business debt consolidation is the practice of combining several interest-bearing loans into a single loan, so instead of paying several monthly bills, you have one.

Debt isn't inherently bad; it's where most of the funding for small businesses comes from, and it can be a lifesaver when emergencies arise or you want to take advantage of an opportunity to grow. Yet for many small business owners, debt carries a stigma.

"Small businesses tend to think debt is bad, and quite honestly, when it comes to small businesses, taking on capital and focusing on capital management is what actually helps expedite the growth of the small business," Kristyn Squires, national small business sales leader at KeyBank, told Business News Daily. "Small business owners should always look at ways to increase capital flow and lower the interest on debt."

Editor's note: Need an alternative loan for your business? Fill out the below questionnaire to have our vendor partners contact you with free information.

 

But all business loans aren't created equal. Sometimes, you end up paying a lot to meet a short-term need. After time, those loans can weigh you down – especially if the interest rates are all over the place and you're struggling to manage it all.

Small business debt consolidation loans work like personal debt consolidation in that you streamline your payments. Years ago, banks were the only game in town, but these days, options abound for consolidating your business debt.

The process is easy: You determine what debt you want to pay down, apply for a loan and use the proceeds to pay that debt. Then, you have only one payment to make each month.

Key takeaway: Consolidating your debt into one payment makes it easier to manage.

Small business owners have many options for debt consolidation loans. From government-backed loans from banks to alternative loans from online lenders, there are lending products to fit most business owners' needs.

Many small business owners turn to their local bank for their lending needs, which makes sense, since they already have a relationship with that bank or credit union. These financial institutions may not be as tech savvy as a mobile bank, but they can offer competitive interest rates and favorable terms for a small business loan.

However, getting a loan from a bank isn't easy. Ever since the 2008-2009 recession, small businesses have been largely ignored by the big banks that tightened their underwriting standards. They prefer to lend to established businesses that can show strong revenue growth and have a business owner with a top-notch credit score.

"For small business owners, it's almost better to have a local bank that you have a personal relationship with," said Josh Knauer, adjunct professor of entrepreneurship at Carnegie Mellon University and founder and general partner of JumpScale.  "But if you're borrowing from a traditional bank, the business owner may have to put up collateral." [Interested in learning about loans from alternative lenders? Check out our picks for the best business loans.]

The U.S. Small Business Administration (SBA) works with financial institutions to offer several types of loans, some of which can be used for everything from purchasing new equipment to consolidating debt. Because the federal government backs a large portion of these loans, lenders are more willing to extend cash to small businesses.

The interest rates on SBA loans are competitive with what borrowers would get at a bank, and some of these SBA loans come with ongoing support to help business owners start and run their businesses. These loans have lower down payments than traditional loans, and some don't require collateral.

The most popular SBA loans are the 7(a) loans and 504 loans. Here's a breakdown of the terms and requirements of the different SBA loan types:

  • Standard 7(a): With this SBA loan, small business owners are eligible to borrow up to $5 million, with the government agency backing 85% of the loan up to $150,000 and 75% of the loan above that amount. The interest rate on this loan can't exceed the SBA maximum of 8%. The turnaround time from application to funding tends to be five to 10 business days. Lenders don't have to require collateral for loans up to $25,000. 
  • 7(a) Small Loan: With this type of loan, which is geared toward smaller businesses, owners can borrow up to $350,000, with the SBA backing 85% of loans up to $150,000 and 75% of loans above that amount. Collateral isn't required for loans of $25,000 or less. As with the Standard 7(a) loan, it usually takes five to 10 business days to get funding. 
  • SBA Express Loan: The SBA Express Loan is similar to the 7(a) loans, but it's faster. It may take as little as 36 hours to receive this loan. Borrowers can get up to $350,000, with the SBA guarantying 50% of the loan value. It can be used as a revolving line of credit or a term loan. 
  • 504 Loans: These SBA loans provide small business owners with long-term, fixed-rate financing. The SBA provides 40% of the costs, a bank covers 50% and the borrower is responsible for 10%. These loans are used primarily to purchase fixed assets that will either help a business grow or modernize outdated systems, not consolidate debt.

Alternative lenders splashed on the scene in the wake of the Great Recession, offering business owners and individuals access to money when other lenders wouldn't. Today, there are many alternative lenders, often referred to as online lenders, that cater specifically to small businesses.

Loans from these types of lenders – which include direct private lenders, marketplace lenders and crowdfunding platforms – typically charge higher interest rates than banks or the SBA, but they tend to have less-stringent underwriting standards.

Online business loans have various amounts and terms, with alternative lenders offering products such as installment loans and short-term loans. For debt consolidation, the installment loan is often the best option for small business owners. With an installment loan, you get a lump sum that you pay back at regular intervals, until the loan and interest are paid off. The interest rate tends to be fixed, so there's no doubt about how much you have to pay monthly.

Key takeaway: If your business has strong revenue and you have a great credit score, a bank or SBA loan is the way to go. If you have less-than-stellar financials, consider an alternative lender.

There's more to choosing a small business consolidation loan than looking at the interest rate; you have to weigh other factors, such as the terms and the lender, very carefully. Before you apply for a business consolidation loan, follow these steps:

Consolidating your debt into one payment is an alluring prospect for many business owners, but it has to make sense from cash-flow and interest-rate perspectives. Before you begin shopping for a debt consolidation loan, think about why you are doing it in the first place. Do you want to lower your interest rate, or do you just want a more manageable payment schedule? Do you need the loan quickly, or can you wait several days for approval, and even longer for funding? The reasons you're consolidating the debt will dictate how you shop for a loan.

It's also important to know your credit score and your business finances. Most lenders require a minimum credit score and time in business for businesses to be eligible for small business loans. If you have a great credit score and solid finances, you're more likely to get approved for a bank or SBA loan than someone who doesn't. If you have less-than-stellar credit, an alternative lender may be your best option.

Before you sign any debt consolidation loan applications, make sure you carefully read the fine print on your existing loans. After all, if a lender charges you a prepayment penalty, that has to be factored into your decision-making process. It may turn out that the fee is negligible, or it may cause you to rethink consolidating your debt.

The last thing you want to do is consolidate your business debt and end up with a higher interest rate for a longer period of time. That's why it's important to review all of your existing debt, looking at the interest rates, fees, minimum balances and due dates. From there, you can determine if it's worth it to consolidate the debt. If you have a lot of monthly loans that have low interest rates, it may end up being counterproductive to consolidate them into a single loan.

However, that may not matter to small business owners who can't manage the disparate loan payments each month. If having multiple bills due means you're missing payments and hurting your credit score, it's better to consolidate into a loan with a slightly higher interest rate.

If you're aiming to shore up cash flow, you may want to consolidate the debts with terms that are the shortest or require you to make the biggest monthly payments. If you care most about simplifying your life, consolidating all of the debt may be the best option.

Once you know why you're consolidating your debt, you can get down to the business of comparing the terms, fees and interest rates. Compare the lenders based on the total cost of the loan and how long you have to pay it back. The APR, or annual percentage rate, includes the interest rate and any fees associated with the loan; it's the total cost to borrow money. You should also find out if there are any prepayment penalties.

When you're shopping for a small business debt consolidation loan, you should also consider how you will make payments each month. If you prefer a streamlined process, you may look for an online lender or a more tech-savvy bank. If you prefer to send a check in the mail, a bank or credit union may be a better choice.

Before you apply, get an estimate of how much your monthly payment will be and the interest you'll pay over the life of the loan. Armed with that information, you can make an apples-to-apples comparison of the lenders. A good rule of thumb is to compare at least three offers before deciding. 

Before you begin the application process, get all of your documentation in order, and have it at the ready. The quicker you're able to provide tax returns, bank statements, your business's financial statements and a copy of your business plan, the sooner you'll get your funding. If the lender has to keep coming back to you for more documentation, it could delay the entire process.

Key takeaway: To choose the right debt consolidation loan, you have to know your business and do your homework. Not all lenders are created equal, which means you have to carefully compare the rates, fees and terms of the loans.

Consolidating business debt makes sense for several reasons. Here are three to consider:

  1. It lowers your interest rate. When you consolidate your debt into one loan, it often lowers your interest rate. That is welcome news to business owners, especially during the COVID-19 pandemic when cutting costs can mean the difference between surviving and going under. 
  2. It's easier to pay. One of the biggest reasons small business owners choose to consolidate business debt is to streamline the payment process. Instead of having to mail several checks a month or log on to multiple lenders' websites to make payments, you make only one payment if you consolidate your debt.
  3. It frees up cash flow. When you consolidate your debts, you're often given a new loan with fresh terms. Lenders may let you decide whether to extend the term, which gives you the option of lower monthly payments. However, be aware that this will cost you more in interest over the life of the loan, so you need to decide if a longer term is necessary to improve your cash flow or to provide you with more flexibility for pursuing an opportunity or purchasing equipment.

Debt consolidation loans provide a lot of benefits to business owners, but they can also be risky. Here are the three big downsides: 

  1. Loan terms are extended. When you consolidate your debt, you're starting fresh, which often means you're extending the term of your loans and, ultimately, paying more in interest. Worse, if you take out the business loan and it doesn't help your business make more money, you'll end up in a bigger debt hole.
  2. You need a top credit score to get the best rates. Buyer beware: Everything isn't always as it may seem when you're consolidating your business debt. Depending on your credit score, you may have to pay more interest than what's advertised. "If you can get a well-structured deal, right now interest rates are pretty low," Knauer "But with debt consolidation loans, the best deals are for the people that don't need them."
  3. It's not a miracle cure. Consolidating your debt makes it easier to manage, but it doesn't erase what's owed. Nor does it address the reasons you got there in the first place. The last thing you want to do is pay off your debt, only to rack it up again.
Donna Fuscaldo

A lifetime New Yorker, I am a veteran finance and business journalist that has contributed to several national media outlets including Forbes, Investopedia, and Bankrate.com. I have spent my career providing consumers and business owners with advice and guidance to help them navigate the world of finance. As a senior finance writer, I report on all aspects of finance from managing cash flow to choosing the best accounting software.