The What, When and Where to Refinance Business Loans
August 14, 2019 | Last Updated on: July 20, 2022
August 14, 2019 | Last Updated on: July 20, 2022
We’ve all made choices at some point that we wish we could undo or change. Those choices can be especially stinging when they involve money, and even more so when that money is moving out the door to pay for a loan with a high interest rate, ridiculous hidden fees, a huge principal payment, or all three at once. This situation not only leaves you with a bad feeling, but with lots of extra cash outflows with zero benefit it can be extremely damaging to a growing business.
The business world isn’t always forgiving of mistakes, but there are plenty of ways to fix a financial decision that isn’t exactly paying off. Loans specifically have several options to change structure, payment, and terms, but for this article we are going to focus on the most widely-known and most popular option: Refinancing.
Let’s say that you’re a business owner who has been making loan payments on your company’s credit facility for a few years now. Your company had been operating for less than a year when you first took the loan to buy the building, and the terms you were offered by several different lending companies turned out to be less than stellar because of your short time in business. Needing the new facility to help your business grow, you took the loan anyway, but you’re now saddled with a high interest rate and servicing fees.
You could continue making payments on that old loan until you pay it all back, but refinancing first could save you thousands of dollars over the life of the loan. At its core, refinancing is simply the process of taking a new loan with more favorable terms to pay off the old loan. The underlying asset or collateral remains the same and the total principal is the same, but the payments and most likely the interest rate will change (for the better).
Beyond replacing an expensive loan with a more reasonably structured one, business owners might also choose to refinance in order to draw some of the equity out of a property or asset. This is pretty common in commercial real estate and elsewhere, as the business owner takes a loan to buy a property, makes some changes to increase the value of that property, and subsequently refinances to take advantage of the new value of the real estate, taking the leftover cash to repay investors or put to work for the business.
This process looks more familiar, but works the same way, on the consumer side. Specifically you’ll probably think of refinancing a home mortgage. There, a person can receive a new loan for their home with a better interest rate or to withdraw any equity they’ve built while making payments over time.
One of the biggest questions to ask when considering whether you should refinance is why. Why does refinancing appear to be a good financial choice? Second to this, assess whether or not your financial and credit situation has improved since you applied for the original loan. If you’re not better off today than you were back then, you probably won’t be approved to refinance (at least not at terms that work for your business).
If you are pursuing a refinance because the payments and interest rates on your current loan are unsustainable for your business, but your revenues and credit scores (business and personal) haven’t changed, you’re only setting yourself up for either failure or disappointment – sometimes both. Applying for a refinance when your business is not performing any differently than it was the first time around will not likely result in more favorable loan terms.
Your original loan may also have some built-in risk management from the lender, who wanted to make sure they get their money’s worth from the deal. A very common way of doing this is a prepayment penalty, where the lender charges the borrower a fee to pay off or refinance before the original loan’s term has run its course. These fees are usually based on a percentage of the original principal amount, which can reach very lofty sums for larger commercial loans. This fee can wipe out much of the savings you might be hoping to get from a refinance.
Refinancing makes the most sense for business owners whose company and operations have grown, and for those who have worked to improve their credit scores and balance sheets. The refinance process will work well for those people because it is being used as a financial tool to spur growth and save money in the long run.
The world of business lending is full of banks, credit unions, online lenders, and others that offer both business loans and refinancing. Where you choose to refinance will depend on a few factors:
The old standard of getting three quotes before contracting with a vendor has stuck around for a reason. Gathering rates and information from multiple lenders will not only help you get a good feel for your options and understand where you stand, but it can also save you money by encouraging lenders to offer you the best rates and terms for your refinance.
Just as you should have done when applying for the original loan, take the time to understand what you’re stepping into with the refinance. Researching your options and shopping around to get the best rates are very important for obvious reasons, but performing a thorough business financial health check is just as vital. Knowing your business and assessing how its situation has changed (ahem, hopefully improved) since you first applied for a loan will give you the best opportunity for a successful refinance.