Business Debt Consolidation and Loan Refinancing Explained

Business Debt Consolidation and Loan Refinancing Explained

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Businesses frequently borrow money to get started, keep running and grow. Debt can fill the gap caused by a lack of cash. You receive an infusion of funds while agreeing to repay the loan with interest in a series of installments over the lifetime, or term, of the loan. The size and timing of each installment will vary with each loan agreement, the amount borrowed, the interest rate and the number of installments. Business debt consolidation and loan refinancing are loan modification techniques to reduce the financial burden of one or more existing loans on your business.

How Do Business Debt Consolidation and Loan Refinancing Work?

Debt consolidation and loan refinancing are aimed at reducing your monthly debt service expense, or the amount you shell out each month for principal repayment and interest charges. The two terms are closely related but not identical.

  • Debt refinancing means you change the terms of an existing loan to reduce your monthly cash outflow through a lower interest rate, a longer repayment term or both. It can also be used to replace a variable-rate loan with a fixed-rate one or vice versa.
  • Debt consolidation combines multiple loans, credit card debts and/or merchant cash advances into a new single loan, potentially resulting in lower monthly payments.

Both techniques involve applying for a new loan with either the original lender or a new one. The application process is similar to the one you underwent for the original loans. The lender will ask for information about your business's finances and often your personal finances, too. The Small Business Administration offers refinancing and consolidation loans with excellent terms, but eligibility restrictions apply. You can also turn to banks and commercial lending companies to provide these types of loans. The lender will check your business and personal credit score and credit history, your latest financial statements, your recent operating results, and changes to your business's equity. If the new loan is approved, you or the lender repay the existing one(s) and establishes a repayment schedule for the new loan.

Pros and Cons to Consolidating or Refinancing Business Debt

Consolidation and refinancing share the same pros and cons, although special considerations may pertain to either.


Lowers monthly expenses: Refinancing reduces your monthly expenses because you'll typically get a lower interest rate or a longer repayment term. The ultimate cost of the loan may increase despite a lower interest rate if the term is extended significantly. That's because you will pay less each month, giving interest more time to accrue on the remaining balance. A consolidation loan may reduce your monthly expenses even without a reduced interest rate because you replace several multiple minimum payments with a single one that might be lower. In addition, the consolidated loan might have a longer term than the average of the existing loans, thereby requiring smaller monthly expenditures.

Allows additional borrowing: You might qualify for additional borrowing by virtue of the reduced cash outflow afforded by a loan refinance or consolidation. Lenders often calculate your debt service coverage ratio (DSCR) to gauge how much money to lend you. If your DSCR rises due to your new loan arrangements, the lender might be willing to increase the amount on the new consolidation or refinancing loan. This allows you to receive an additional cash infusion without taking out a separate short-term loan.

Consolidation simplifies cash-flow management: Loan consolidation lets you replace multiple monthly payments with a single one. This makes it easier to manage your cash flows and ensure you have the money available to make the one monthly payment.

Consolidation replenishes revolving credit lines: If your loan consolidation pays off credit cards and other revolving credit lines, you will once again have access to these when you need them, giving you additional financial flexibility.

Refinancing makes payments predictable: Refinancing variable-rate loans with fixed-rate ones allows you to better plan your cash flows because you know exactly how much you'll pay each month. This is more efficient because you won't have money sitting idly to act as a cushion against a higher variable payment.


May increase total costs: As noted above, even if a refinance or consolidation loan reduces your interest rate, the total cost of the loan might increase if the term is significantly extended. You can use an online loan calculator to check the cost of a refinance or consolidation.

May require personal collateral: The terms of the new loan may require you to pledge personal assets, such as your home, as collateral, even if this was not required for the original loan(s). This increases the risk to your personal wealth should you default on the loan. It also means you won't be able to sell the asset or use it for collateral on another loan until the current loan is repaid.

May encourage increased indebtedness: As noted earlier, refinancing and consolidation will probably increase your DSCR, which could tempt you into taking on additional debt. If your company hasn't solved the underlying issues that led to the original debt, piling on new debt might increase the chances of insolvency and bankruptcy.

May reduce credit score: Applying for a refinance or consolidation loan requires the lender to perform a hard inquiry on your credit report, which could lower your credit score by a few points for a year or two. The minimal effect should be balanced by the positive effects of a higher DSCR.

When Should You Consolidate or Refinance Business Debt?

In general, the best time to consolidate or refinance your business debt is when you and your business have become more creditworthy, as this should facilitate loan approval and better terms. Here are several scenarios.

Your personal credit score and finances have improved: Many business loans are contingent upon the owner's creditworthiness. Boosting your credit score significantly will make your loan application more attractive. A higher credit score is usually accompanied by an improvement in your personal finances—i.e., greater wealth or less debt.

Your business finances have improved: Waiting for your business's finances to improve before applying for refinancing or consolidation increases your chances of getting the new loan and saving money on interest. This means showing three to six months' of improved net profit, lower debt ratios and better operating income. Other indicators of improved business finances are an increase in annual revenues, a higher DSCR, an addition of assets or an increase in asset values, and reduced utilization of existing available credit.

Time has passed: Your business's creditworthiness increases the longer you've operated your business, as it gives lenders greater evidence of your ability to repay the loan. Some lenders require your business to have operated for a year or two before they will consider refinancing or consolidating a loan.

Interest rates drop: If interest rates decrease by a percentage point or more, the total cost of your loan should decrease by replacing the older one(s).

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.