- Refinancing a business loan may not always be the best solution. It's important to know when a good time is to refinance a business loan.
- Before moving forward with refinancing, there are a few things to consider, including is refinancing worth it, what are your current terms and what do you want to accomplish through refinancing?
- Refinancing a business loan has its pros and cons, both of which should be carefully weighed before signing a new loan contract.
Perhaps the original terms of your business loan might have worked well for you when you took out the loan, but you're in a better financial position now. Or maybe you had to apply for a business loan with less-favorable terms due to how quickly you needed access to capital.
No matter your reason, the idea of refinancing business loans and landing a more manageable payment plan is thrilling to most business owners.
If you're considering refinancing, it's important to make sure you understand the details before you sign on the dotted line.
What does it mean to refinance your business loans?
When you look into refinancing, your general goal is to make your debt less expensive or easier to manage. That can mean a better APR, a longer repayment period or lower payments, whatever it is that makes the loan better for you.
With refinancing, you'll pay off your original loan in a lump sum and take on one with more favorable terms.
Why would you refinance?
Simply, to get a better business loan for you. No lender ever wants you to drown in debt – they make their money from you repaying your loan, not from defaulting – so getting more manageable terms could benefit both parties involved, especially if it means you are more likely to make your payments on time.
You also may want to refinance to consolidate your debt. If you have multiple sources dragging you down, consolidating your loan into a single source of debt through refinancing can make your debt more manageable.
Types of business loans that businesses might refinance
When considering refinancing a business loan, you may have several options:
- Refinancing business debt with a bank loan. Consolidating or refinancing your business debt through a bank loan may provide lower interest rates. This type of refinancing is a great way to avoid a balloon payment.
- SBA refinancing. An enhanced SBA business loan is a beneficial financing option for small business owners, because of the low interest rates and low down payment requirements. There are a few different SBA loan programs that are available to help refinance your business debt, for instance, SBA 7(a) loan program can be used to refinance your existing business debt, as long as your new loan is secured with the same security as the previous debt and SBA 504 refinancing is an option for eligible small businesses that are planning an expansion.
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Important things to know before you attempt to refinance
Think you're ready to refinance? Before you go forward, make sure you know the following:
1. Not all lenders allow refinancing
Before you go into the process of applying for a better loan, make sure that the terms of your original business loan include the ability to refinance. Not every lender permits refinancing, so before you move forward, double-check that you can.
2. Your business's vital signs
The terms of your loan are issued based on your credit score, revenue, time in business, cash flow and other essentials that indicate to a lender your company's financial health. You can think of these like vital signs. Have they improved since the last time you borrowed money? If they haven't, you might want to wait until you can demonstrate financial improvement to apply for refinancing. Remember that every lender assesses your risk as a borrower. If you haven't proven to them that you're a low-risk candidate, you're less likely to find more favorable terms.
3. What you want to accomplish
What are you hoping to find when you speak to lenders? Do you want to find a loan that will lower your monthly payments? Are you hoping to extend the term of your loan; for instance, are you looking to convert a short-term loan into an SBA loan? All of these goals are different, and they will all help your business. But the best refinancing opportunity for you should align with the goals you have for your business.
4. Your loan's current terms
Do you know all of the ins and outs of your current loan? Do you know what interest rate you pay and the APR? Do you know how much you have left in both principal and interest to pay off? How is your loan structured? Does it amortize? You get the gist. You can't find the best refinancing terms to suit your business unless you understand the situation you're in now – and the one you want to get to.
5. Not every offer is worth it
Just because you get an offer to refinance your loans doesn't mean that you should take it. Refinancing is a long process, and it's worth it for the right offer. But if refinancing doesn't make a big difference for your business, like making your monthly payments more manageable, or giving you access to working capital for a longer period of time, it might not be worth the trouble. You also could be better served by waiting until your financials improve and then reopening your search for strong offers.
Pros and cons of refinancing a business loan
Just like most other things involved in operating a business, there are pros and cons to refinancing a business loan, so before taking out a new business loan, consider these pros and cons.
Pros of refinancing a business loan
- Lowering the loan payment can help to free up the cash flow within the business, which allows you to invest the extra funds into payroll, inventory, new equipment or other business-related needs.
- Refinancing a business loan often means you are able to get a better interest rate, as well as better loan terms, which can save you money in the long run.
- If the loan refinance will positively impact business cash flow, some lenders may approve you for a larger loan amount that is based on your debt-to-service coverage ratio, and getting approved for a larger loan may eliminate the need for additional loans that are needed for the business.
Cons of refinancing a business loan
- One of the worst things that can happen when you refinance a business loan is that your credit score may be affected negatively, because refinancing will reduce the average age of your credit, and if your score is already low, you may not be qualified for refinancing.
- You may incur prepayment penalties for paying off the original loan early, which may reduce the savings that you would have earned with refinancing.
- Some lenders may require collateral as security for the new loan, even if you didn’t need to have security for the original financing