Refinancing Credit Cards with a Term Loan

American consumers carry $918.5 billion in credit card debt, indebted households owe credit card companies an average of $16,140, and over 50% of new firms rely on credit cards in their first year of business.

These figures, while large, are to some degree unsurprising. It can be difficult to raise capital from friends, family and investors, when a business launches — and it is virtually impossible to get a loan. New businesses that are not yet profitable pose an enormous risk to lenders. Credit cards offer an attractive way to manage finances. Applications do not require a business plan or months of waiting, and the cards are accepted almost everywhere. Credit cards smooth out the business operations of new ventures and established companies alike.

These benefits notwithstanding, carrying revolving debt can be risky and many new business owners do not realize the costs of letting this debt accumulate unnecessarily.

When credit card debt costs more than you think

The good news for business owners is that using credit cards to jumpstart your business appears to have no bearing on whether or not the business survives.  The bad news, according to the Kaufmann Firm Survey, is that every $1,000 increase in credit card debt increases the probability a firm will shut down by 2.2 percent. Why might high credit card debt threaten the long-term success of a business?

Credit cards have high interest rates and revolving debt. Interest rates across all cards average around 15%, but can be over 30%. This interest does not apply to balances that are paid off before the grace period ends, usually within the month; it is applicable to the debt that carries over from one month to the next. Once you carry this kind of debt, you pay interest on every new purchase. This means that, while you may be making the minimum payment or more each month, you could find yourself overwhelmed with debt you simply cannot afford.

Imagine that business owner, Linda, takes on $50,000 in debt on a fixed-rate card with an APR of 18%, to purchase a piece of equipment.. Let’s assume she doesn’t charge the card again before paying off her debt. If Linda makes a payment of $1,200 every month, it will take her 5 years and 6 months to pay off the loan, by which time she would have paid an additional $29,054.33 in interest. If, on the other hand, she can afford monthly payments of $2,400, she will be able to pay off her debt in 2 years and 2 months with $10,401.95 in interest payments.

When it comes to paying off credit card debt, speed is key to preventing high interest rates from dragging down your business. But there’s another, less obvious price: the opportunity cost. What if instead of making the minimum interest payments over years or larger payments in a matter of months, you reinvested that money in your business?

How refinancing makes debt manageable

Refinancing credit card debt with a term loan means paying off your current debt with a different kind of debt.

Refinancing does not, of course, change the principal amount owed. It does, however, make the debt more manageable by spreading it out according to your business needs, and taking advantage of the lower interest rates that term loans (particularly when secured) offer.

Refinancing frees up capital for business needs, and often also frees up headspace by eliminating the uncertainty and worry that come from carrying revolving debt. (See the story of lighting designer and first-time business owner Bec Brittain)

Let’s return to Linda for a moment. After making her $50,000 credit card purchase, she decides to refinance using a term loan with an APR of 15%. With the term loan, she is able to pay off her debt in 24 monthly payments of $2,353.67, which includes $7,988.17 in interest. She saves approximately $2,400 in interest payments. 

Ready to refinance? Some tips before you start:

  1. Do the math. Find out exactly how much you’ll be saving and spending to refinance with a term loan. Some of the costs you may be eliminating or incurring include:
    • Total finance charge - likely listed as ‘interest charge’ or ‘finance charge’ on your credit card bill, this is essentially the cumulative fee you pay for carrying a balance on your credit card past the grace period.
    • Annual fee - a fee charged for having a credit card, up to $300 a year.
    • Service fees - a charge for using your credit card, often charged monthly.
    • Application fee - A flat fee charged for applying for a credit card or a loan.
    • Origination fee - An upfront fee charged by the lender for processing a new loan. The only fee Bond Street charges is a 3 - 5% origination fee.
    • Appraisal fee - If you’re using real estate as collateral, you will have to pay a fee to appraise the property so the lender knows how much they can expect if you default on your loan.
  2. Do your homework. Check the reputations and terms of potential lenders. Read reviews from other small business owners and schedule phone calls with each lender to ask the hard questions.
  3. Prepare for lenders’ questions. To determine your eligibility and terms, lenders will assess your business fundamentals, looking at your personal and business credit scores, financial statements, tax returns, a copy of the lease or purchasing agreements of real estate, and credit card statements. Bond Street (and most other lenders) will require a personal guarantee.
  4. Do not close your accounts. If you have been using personal credit cards primarily for business and decide to refinance, do not close your accounts even if you cease to use the cards. Doing so could negatively affect your credit score.

More from the Resource Center: An In-Depth Review of Term Loans

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