Refinancing business debt: when consolidating makes sense

Debt tends to build up one sensible decision at a time. A loan for a van, an overdraft for a slow month, a merchant cash advance to cover a tax bill, a credit card for odds and ends. Each made sense when you took it. Together they can mean several payments going out on different days, at different prices, to different lenders.

Refinancing means replacing existing debt with new borrowing, usually on different terms. Consolidating is a type of refinancing where several debts are replaced by one. Done well, it lowers your costs and makes cash flow easier to manage. Done badly, it costs more and hides a problem rather than fixing it. This guide shows you how to tell which is which.

What consolidation looks like

A business might currently be paying:

• a term loan, with a fixed monthly payment and a year or so left to run
• a merchant cash advance, collected as a share of every card sale
• one or more business credit cards
• an overdraft that hasn't been out of the red for months

A consolidation loan pays off some or all of these, and you're left with one lender, one payment and one end date. Sometimes the new lender pays the old ones directly, so the money can't be used for anything else.

The number that matters: total cost

Most refinancing is sold on the monthly payment. It's the figure that feels most urgent, and it's the easiest one to make look good: spread the same debt over a longer period and the monthly payment falls, almost regardless of the interest rate.

The figure that tells you whether you're better off is the total cost: everything you'll pay from today until the debt is gone. Compare two numbers:

1. What you'd pay if you kept your current debts, adding up every remaining payment on each one.
2. What you'd pay with the new loan, including every monthly payment, the arrangement fee, any broker fee and any charges for clearing the old debts early.

If the second number is lower, consolidation saves you money. If it's higher, you're paying for something else, usually breathing room, and you should be clear that's what you're buying. Lending to limited companies isn't always required to show an APR, so ask every lender for the total amount repayable in pounds. Our guide to what a business loan really costs covers the fees to look for.

An illustration. A company has a term loan, a merchant cash advance, a credit card and an overdraft. Their settlement figures, including charges for clearing them early, add up to £48,000. Kept as they are, the payments come to about £4,000 a month, with about £52,000 left to pay over roughly 13 months. A lender offers a single £48,000 loan over three years at £1,650 a month, £59,400 in total. The monthly outgoing drops by about £2,350, which is a real help to cash flow. But the business pays about £7,400 more overall, and it's in debt for three years instead of one. Neither choice is automatically wrong, as long as the owner knows which one they're making. These figures are illustrative, not quotes.

The cost of leaving your old debts

Before you can compare, you need the real cost of clearing each existing debt today, not just its balance. Ask each lender for a settlement figure in writing, and check:

• Early repayment charges. Many fixed-rate business loans charge a fee for repaying early, often a percentage of the balance or a number of months' interest. Your agreement sets out what applies.
• Merchant cash advances. The cost of an advance is usually fixed up front, so clearing it early often means paying the full agreed amount anyway. Some providers offer a discount for early settlement, but only if the agreement says so. See how a merchant cash advance works.
• Regulated borrowing. If you're a sole trader or small partnership and a loan was for £25,000 or less, it's likely regulated by the FCA. You then have a legal right to repay early, and the lender's charge for that is capped. Check the agreement or ask the lender.
• Overdrafts and cards. These usually have no early repayment charge, but closing them changes your available credit, and an overdraft you clear may be reduced or withdrawn.

Sometimes the charges are high enough to wipe out the saving. In that case, consolidating only the expensive debts, and leaving a cheap loan to run its course, can be the better answer.

Security and guarantees on the new loan

Look closely at what the new lender wants in return. This is where consolidation can quietly change your risk.

• Unsecured debts can become secured ones. If you replace cards, an advance and an unsecured loan with a loan secured on property or business assets, you may get a lower rate, but those assets are now at risk if the business can't pay. See secured vs unsecured business loans.
• Personal guarantees can grow. Directors are often asked to guarantee the new loan. If your old debts had no guarantee, or smaller ones, you could be taking on more personal liability than before. Read our guide to personal guarantees before you sign one.
• Old security needs releasing. When an old secured debt is paid off, make sure its charge is formally released and marked as satisfied at Companies House, and that any guarantees you gave for it are ended in writing.

When consolidating is a smart move

Refinancing tends to make sense when the business is basically healthy and the change improves things in a way you can measure:

• The total cost goes down, because the new rate is lower than the average of your current debts, even after fees and charges.
• The business has improved since you borrowed. Better accounts, a longer trading record or a cleaner credit file can mean you now qualify for cheaper money than you could get when you were younger or under pressure.
• Expensive short-term debt is being replaced by cheaper debt that matches its purpose. For example, an advance taken to buy equipment being replaced by asset finance that runs for the equipment's useful life.
• Simplicity has a value you've thought about. Fewer payments, one date and one relationship can free up time and reduce the risk of a missed payment.
• Cash flow needs smoothing for a known reason, such as a large contract that pays in arrears, and you can see how the business will be stronger afterwards.

When it's a warning sign

Consolidation can also be the point where a business with a debt problem makes it bigger. Be honest with yourself if any of these apply:

• You're refinancing to meet repayments you can't otherwise make. If the business isn't generating enough cash to service its debts, a new loan delays the problem without changing it.
• You've done it before. Repeated refinancing, or taking a new advance to clear an old one, is a common pattern in businesses that later struggle.
• There are arrears with HMRC, suppliers or lenders as well as the debt you're consolidating.
• The only offers left require security you'd be devastated to lose, such as your home, or come with costs that make the total jump sharply.

None of this means you can't refinance. It means you should talk to your accountant first, and if the business is struggling more widely, speak to a licensed insolvency practitioner or a free business debt charity early, while you have the most options. Directors of a company that may be insolvent have extra legal duties to consider creditors' interests, which is another reason to get advice promptly.

Don't turn short debts into long ones without meaning to

One trap deserves its own section. Short-term debt is usually taken for short-term needs: a seasonal stock order, a tax bill, a gap before a customer pays. When it's rolled into a three or five-year loan, you keep paying for that need long after it has passed.

That has three costs. You pay interest for longer. The business carries the debt into future years, which can make it harder to borrow when the next need comes along. And the next short-term need often gets funded with new short-term debt, so the cycle starts again on top of the long loan.

A sound rule is to match the new term to what the money was originally for. If the debt funded something that lasts, such as equipment, premises or a vehicle, a longer term can be reasonable. If it funded something that's already been used up, aim to clear it as quickly as you can comfortably afford.

What lenders look at

A lender considering a consolidation loan wants to see that the business can afford the new payment comfortably and that the refinance improves its position. Expect to provide:

• A list of every debt, with the lender, balance, monthly payment, end date and settlement figure.
• Recent business bank statements, usually the last three to six months, showing all the existing repayments going out.
• Your latest filed accounts, plus management accounts if your year end was some time ago.
• The reason for refinancing, in a sentence or two.

A clear explanation helps. "We took a cash advance during a bad winter, trading has recovered, and we want to replace it with a cheaper loan" reads very differently from no explanation at all.

Common mistakes

• Comparing monthly payments instead of total cost. The most common and most expensive mistake.
• Forgetting early repayment charges on the debts being cleared.
• Keeping the old facilities open and using them again. If you clear cards and an overdraft and then fill them back up, you've doubled the problem.
• Signing a broader guarantee or security than the old debts had without noticing.
• Refinancing every year. Each round adds fees and resets the clock.
• Leaving out a debt. Lenders will see it on your bank statements and credit file, and it undermines trust.

Questions people ask

Is it a good idea to consolidate business debt?

It can be, if the new loan costs less in total than your current debts after any early repayment charges and fees, and the payment is comfortably affordable. It's less likely to be a good idea if it only works by stretching the term, or if you need it to keep up with payments you can't otherwise make.

Will consolidating lower my monthly payments?

Often, yes, especially if the new loan runs longer than the debts it replaces. But a lower monthly payment over a longer term frequently means a higher total cost. Compare the total you'll repay under each option, not just the monthly figure.

Can I refinance a merchant cash advance?

Yes, some lenders will offer a loan to clear an advance. Because an advance's cost is usually fixed up front, settling it early often means paying the full agreed amount, so check whether your provider offers an early settlement discount before you work out the saving.

Do I have to pay a fee to repay my business loan early?

It depends on the agreement. Many fixed-rate business loans carry early repayment charges, while regulated loans to sole traders and small partnerships have limits on what can be charged. Ask the lender for a written settlement figure that includes any charges.

Will refinancing affect my credit score?

Applying usually involves a hard search, which is visible on your business file and on your personal file if you give a guarantee. Clearing several debts and keeping up with one new loan can strengthen your record over time. Applying to many lenders at once can count against you, so start with checks that use soft searches.