Guide to Refinancing Business Loans
Small business loans are essential to running nearly every small business; however, refinancing options crop up from time to time that can change the terms of an original loan into a more palatable loan going forward. Refinancing, or the act of taking out a new loan to pay off an old one can be complicated and difficult to properly time. But if done correctly, refinancing existing debt can make changes to your company’s debt portfolio in ways that can lead to better credit, greater cash flow, and cleaner books.
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Everything you Need to Know About Refinancing Business Loans
As a small business owner, you may have the opportunity to refinance a loan at some point in time. That is why it is important to be prepared and know what you will need to have lined up, so you are best positioned to optimize this financial opportunity. In this guide, we will be discussing everything you need to know about refinancing business loans.
Why Refinance Your Business Loans?
As with any large financial decision you make for your company, you must have a proper goal in mind when it comes to refinancing. Typically, there are a few significant reasons to refinance business loans, whether you’re looking to pay off an existing credit card or an old term loan you received as a startup.
Lower Your Interest Rates
The first reason you may consider refinancing is that doing so could net you a smaller interest rate on an existing loan. Depending on the difference in your company’s creditworthiness between the time of the original debt and the time you’re considering refinancing, lenders may offer you the same principal and repayment terms but with a lower interest rate to go along with them.
Let’s say, for the sake of example, that you take out a business loan for $250,000 at 7% interest and 60 months to repay. Using biz2credit’s Small Business Loan Calculator, we can see that you’ll be making monthly payments of about $4,950 and you’ll pay a total of $47,018 in interest over the lifespan of the loan.
But if your credit improves after a couple of years of paying down that debt, refinancing could save thousands. Consider that same loan at a 5.5% interest rate. Now payments drop to $4,775 and you’ll pay $36,517 in interest.
While you’d obviously like to have the best possible credit from the outset, refinancing an existing loan to reduce interest can make the difference between that $47,018 and a total closer to $36,517. Even slight improvements to your credit score can lead to paying significantly less interest on existing business debt.
Change Repayment Terms
But reducing total interest isn’t the only possible benefit of refinancing your loans. You could also use your improved business credit to refinance existing debt in such a way that you shorten or lengthen the repayment terms. You can sometimes make the debt more manageable by stretching out the required time for repayment or compressing it.
Again using the biz2credit Small Business Loan Calculator, we can see that a small business loan of $30,000 with an 18-month repayment term at 6% interest will require monthly payments of $1,747. However, if you were to refinance that loan to extend the repayment term by even six months, that payment drops to $1,329. That’d save your business over $400 per month on the same debt (though you’d pay slightly more in total interest).
Conversely, that same $30,000 loan at 6% interest could have its repayment term shortened by six months. In that case, monthly payments go up slightly, but you’re paying less in total interest even though the rate of interest is the same.
Change payment frequency
Most loans are repaid using regularly sized monthly payments. However, many small business owners find that they’re able to keep cash flow healthy with less-frequent payments. Making payments less often than once per month can keep more cash in your company’s coffers while paying down an existing debt.
Simplify Your Debt
Many small business owners also use refinancing to consolidate current loans. Debt consolidation is the act of using a new loan to pay off existing debt and then making payments on the new single loan instead.
Debt refinancing can be particularly helpful if you’ve had a few short-term high-interest loans. By combining several debts into a larger, longer-term loan you may find that you’re making smaller payments and paying a smaller interest rate.
When to Refinance Business Loans
The best time to refinance business loans is when your qualifications as a borrower are ideal for accomplishing the goal you’ve chosen from the list above. In short, there are a few situations in which it may be most ideal to refinance.
Your Credit Has Improved
It can be difficult to get the perfect loan when you‘re borrowing for a new business. You’ve got a limited credit history, few assets, and quite possibly low income. If you’re running your business well and your business credit score has jumped considerably since the underwriting of your initial financing, refinancing could be a great option.
There are many ways to boost your credit score over the short and long term. The most prominent factors include the size of your company, the length of its credit history, total debt, and the amount of available credit that’s currently being utilized. In particular, those last two factors are helpful for short-term increases in your score, allowing for an ideal refinance.
Interest Rates are Low
Among its many duties and purposes, the United States Federal Reserve, or Fed, sets interest rates at which traditional banks borrow money, and, by extension, the interest rates that those traditional banks can offer small business owners.
The Fed raises and lowers rates to spur and impede lending in order to try to control inflation. Refinancing might be wise for your business at times when interest rates are at their lowest. If the lending financial institution isn’t paying much for its money, it’s likely you’ll pay less as well.
You’ve Made Significant Progress on Existing Debt
In general, lenders will not give ideal repayment terms to borrowers looking to refinance large debts that haven’t been paid significantly down. A refinance loan is likely not going to be for the same amount as the original loan, so make sure that the refinanced portion is paid significantly down. It’s also important to note that paying existing debt also boosts your credit score, meaning that the new lender has even more incentive to lower rates in your refinance.
You’re Struggling to Make Payments
Refinancing is a good way to lower monthly payments to your current lender. So if you’re currently struggling with your company’s level of cash flow, refinancing could free up extra dollars every month to purchase inventory, pay employees, or take care of the expenses necessary to keep the doors of your business open.
How to Refinance Business Loans
So, you know why you’re ready to refinance. You know that the time is right. How do you refinance a small business loan?
Well, the process looks very similar to the application process for the loans you got when you were just a startup. Refinancing is, after all, paying for something with a loan. And just like with an initial loan, there are several options for the exact method you use to refinance.
You can use a traditional term loan to refinance your existing loans. Term loans, also known as traditional bank loans, are a form of lending in which a financial institution doles out a certain loan amount in exchange for monthly payments, including an agreed-upon interest rate. The size of your loan payments will depend on the length of the loan’s repayment terms, your interest rate, and the size of the loan.
Even if the purpose of the loan is to pay off and refinance a different loan, the lender’s primary motivation is still to make money. That means that qualifying for a term loan to refinance existing will require a high degree of creditworthiness. To receive the terms you need to make refinancing worth it for you, you need to show the lender that you are a safe bet for their money.
Because of the stringent eligibility requirements of traditional term loans, businesses these loans are sometimes offered for significantly large sums at competitive interest rates, making them great options for refinancing your existing debt, whether that means clearing a business line of credit, a previous term loan, or any other type of debt.
SBA 7(a) Loans
The United States Small Business Administration (SBA) uses taxpayer dollars to guarantee several loan options. Most common is the 7(a) program. Financial institutions offer loans to small business owners and a large percentage (up to 75%) of the loan is guaranteed by the SBA, meaning that if the borrower is for any reason unable to repay the loan, the government has protected the bank from undue financial damage.
Because every SBA loan is guaranteed by taxpayer money, lenders are particularly careful about the businesses to whom they’re lending. Certain types of businesses, from those involved in gambling to certain types of investment real estate companies, are not eligible. And the qualifications are steep. However, if you’re able to qualify, the SBA guarantee makes it likely that the financial institution can offer you a better loan than the institution would be able to otherwise.
SBA loans can be used for a wide variety of business needs. You can use them as working capital, to finance equipment or real estate, or to acquire another company. But they‘re great for refinancing. Particularly if your company is shown to be much more creditworthy than it was at the outset, refinancing using an SBA loan is a great option.
Finally, you could seek to refinance existing debt with online lenders like biz2credit. These lenders can often move more quickly than traditional banks - you can sometimes receive a loan offer within a single day. In addition, many online and alternative lenders are able to offer loans to businesses with fair or even poor credit.
On the whole, online lenders offer loans with shorter terms and higher interest than a traditional loan, which make them great options for when you’re looking to refinance in order to shorten a loan’s repayment term.
Another huge plus is that alternative online lenders are able to often a wide variety of products in addition to the fact that they move quickly and offer loans to a wider variety of businesses. You can refinance an equipment loan with a merchant cash advance, for example.
Should You Refinance Your Business Loans?
All of this is not to say there aren’t certain drawbacks to refinancing your loans. As with all aspects of business finance, there’s a give and take with each aspect of the process, and getting started with a business loan is always a complex but important state of the process.
Depending on the reason behind your refinance, your financial health, and the type of loan you’ve gotten to refinance existing debt, you may find that your total interest payments may be larger than the original loan’s interest total. You may find that your credit is affected by a hard credit check, or that you may need to put up an asset or assets as collateral. In some situations, loans carry a prepayment penalty if you pay them off before a particular time.
But if you time your refinance well - when the economy, your company, and your credit all line up correctly - you may find that refinancing your business loans sets you up for growth, greater cash flow, and less expensive borrowing down the line.
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