Under the right circumstances, using a business loan to pay off credit card balances can be a savvy move to manage debt. This is known as debt refinancing. It’s a strategy that can deliver numerous benefits for you and your business under the right circumstances.
Business credit cards can be a convenient source of capital and a great way to build your company’s credit score. Over half of all small business owners use credit cards regularly to bring in external funding. Still, it can be easy to let these balances swell out of control thanks to high interest rates and excessive fees.
Paying off your card can take years if you only pay the minimum due each month. If you’re feeling overwhelmed by your credit card obligations, debt refinancing may be a better solution, though it’s not for every company.
What Is Debt Refinancing?
Debt refinancing is taking out new debt to replace old debt. For example, taking out a business loan and using the cash to zero out the balance on a higher-interest credit card.
When you use business loan funds to pay off credit card debt, your new loan’s initial balance will be the same as the balance on the account you are paying off. It could be even higher when the following fees are added:
- Underwriting fee — Banks use underwriters to examine and verify the bank statements, tax returns, and financial reports that you submit along with your application. Underwriters charge an extra fee for their services, which is rolled into your loan.
- Origination fee — Origination fees are charged at the beginning of your loan to cover processing costs.
- Loan guarantee fee — If you receive your loan through the U.S. Small Business Administration (SBA), there is an additional fee that ranges from 0.25% to 3.75% of the loan amount. The lender pays this fee in exchange for the SBA’s guarantee to pay the loan if you default, but lenders usually pass the extra charge on to the borrower.
- Closing costs — These are additional miscellaneous fees that cover the bank’s expenses for servicing your loan.
Despite the extra costs associated with a business loan, debt refinancing can potentially save your company money — both with a lower monthly bill and with long-term cost savings over the life of the loan.
Debt Refinancing Advantages
The key to successfully getting out of debt lies in finding the best terms possible. Low-interest rates and long repayment periods will help to maximize your benefits.
Save Money Long-Term with Lower Interest Rates
You can save money over time by taking out a loan with a low Annual Percentage Rate (APR) and paying off higher interest credit cards. More of your monthly payment is applying to the loan principal with a lower interest rate, and less is being siphoned off to cover finance charges. You will pay off your debt faster, and your total costs will be lower.
Save Time with Simpler Debt Tracking
Debt refinancing can also mean debt consolidation — this involves centralizing your debt by using the loan proceeds to pay off multiple credit card accounts. Tracking your debt will be much easier with just one balance and one monthly payment to think about.
Potential for Lower Monthly Payments
Some business loans offer low interest rates along with a relatively long term. If you can spread your repayment out over four or five years or even longer, your monthly obligation will be lower. With the correct loan terms, you could be paying significantly less than what was due each month on your credit card statements.
Debt Refinancing Disadvantages
Long-term revolving credit card debt is costly, so clearing this debt off of your balance sheet’s liability column is almost always a wise financial decision. However, there are sometimes disadvantages to using a business loan to do so.
Only Works if You Have Strong Credit
The only way debt refinancing makes sense is if your business loan has a lower interest rate than the credit card or cards you will be paying off. If you have a poor credit history, it may not be possible to qualify for a low APR loan.
With a mediocre interest rate, even if it is lower than your credit card APR, your payments on the new loan might not be low enough to offset the loan fees. The loan could end up costing you as much as the credit card debt.
Collateral Requirements Put Your Property at Risk
Credit cards are unsecured, which means you do not have to pledge assets to the issuer in exchange for the funds. On the other hand, business loans generally require collateral to offset some of the lender’s risk. If your sales drop and you can’t make your loan payments, you risk losing your business or personal assets.
Doesn’t Address the Root Cause of Financial Trouble
A loan can solve the short-term pressure of your monthly credit card payments, but it won’t solve the underlying issue that caused the debt in the first place. You may also need to look at ways to trim or restrain spending to ensure you don’t overspend on your credit cards and end up right back in the same situation.
You Could Pay More in the Long Run
Make sure you calculate both the short-term and the long-term costs of the loan. Your monthly minimum payments could be significantly lower, but if you spread out your repayment term too much, the loan could still cost you more in overall interest.
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