Congratulations for securing a loan for your small business! Refinancing a higher interest loan to one with lower interest and more favorable terms can substantially reduce your business debt. Here are the guidelines for how to know when it’s time to refinance your small business loan, how to evaluate the refinance package, and caveats for when you should avoid refinancing your loan.
When you should you refinance your small business loan? What are the potential benefits of doing so? Let’s look into when and why you should refinance your business loan.
Lower Interest Rates
When assessing your current loan, the primary consideration is the interest rate. A better interest rate may result in a lower monthly payment on the loan. Even a few percentage points can result in thousands of dollars of savings over the life of a business loan. Banks and credit unions may offer the lowest interest rates, both for traditional loans and for refinancing.
Refinancing your high interest loan may result in more working capital for your business if you lower your monthly loan payments. This extra cash flow could be used to pay down any other high interest balances you have. Or you could dedicate the extra cash to day-to-day business expenditures, which in turn, could be allocated to grow your business.
Better Business Credit Scores
You may see a boost in your credit score after reducing your credit utilization ratio. Your credit utilization ratio is the amount of debt you have versus your total amount of available credit. This ratio may account for up to 30% of your credit score rating.
What Are the Fees and Costs of Refinancing?
Refinancing is attractive in many scenarios, but there are certain caveats a small business owner should consider when looking at refinancing to ensure that the refinance meets the business owner’s financial goals.
Do you have an amortized loan?
This is a loan where early payments pay down interest, while latter payments pay down principal. If you have already paid the bulk of the interest on an amortized loan, even if the rate is high, once you are paying down principal on your loan, the cost of refinancing could outweigh any potential savings.
What are the costs of getting a new loan?
Fees and ancillary costs could offset your savings on the loan. There are no fees for SBA loans of less than $150,000, but for SBA loans of $150,000 to $700,000, fees are 3% of the SBA-guaranteed portion, and increase at higher loan amounts.
Do you need to hire an appraiser?
Using commercial or personal real estate as collateral means you need to pay for an appraisal to determine the market value of the real estate. A professional commercial real estate appraiser can charge several thousand dollars.
Have you considered time and manpower costs?
Refinancing can take considerable amounts of time and, of course, paperwork. Do you have the resources to take away from your normal business practices in order to put together all the required documents? It’s a minor consideration, but may be a daunting task for a sole proprietor or beginning start-up with few employee hands on deck.
When Should You Avoid Refinancing?
Refinancing is simply repackaging your debt; even the most favorable terms and rates will not make the debt disappear. Companies that offer to “erase” your loans sound too good to be true, and they are. Performing your own due diligence on the refinancing organization is crucial to avoid predatory lenders.
As a smart business owner, consider the following before refinancing and tread carefully if any of these points pose a concern:
Are you having trouble making payments?
If so, refinancing may simply trap you in a cycle of debt. Many small business owners rely on credit cards or lines of credit, which can become a dangerous cycle that puts the long-term health of their businesses in jeopardy.
Short-term debt solutions for long-term business operations are not viable. Getting stuck in a revolving door of debt may impede your credit going forward, and therefore, your ability to financially sustain or grow your business.
You need to get honest with yourself in case refinancing will point your business toward a downward spiral of debt. A borrower who cannot repay loans may face insolvency, or bankruptcy. In such cases, business assets may be sold at a low value. In addition, any collateral the business owner has used to secure the debt may be at risk, including the business owner’s home or other personal assets.
Beware the balloon payment.
Some borrowers offer the option of a “balloon payment” at the end of the loan. While such a balloon payment may provide the business owner with extremely low monthly payments, in reality, many business owners find that they have to take out a new loan to pay off the inflated balloon number at the end of the loan, which can be a costly prospect.
What if I can’t pay my loan?
If you’re considering refinancing because you are struggling with your current business debt, other options may offer relief. Your lender may be able to assist in prioritizing your business debts. Other possibilities that the SBA suggests for distressed borrowers are formal debt modification plans or deferment. Either may assist if making the minimum payments on your existing loans is a continued burden.
Refinancing a business loan does have advantages, should you qualify for a lower interest rate and should your overall debt burden be reduced by the refinance. However, as is the case with many business matters, refinancing may not prove to be a straight-forward decision. Carefully weighing all pros and cons will ensure the most favorable decision for the continued financial health and vitality of your small business.