What is refinancing?
Refinancing a business loan is paying off your current business loan with a new replacement loan that has different terms that are more advantageous to your new set of circumstances. If you take out cash on your new loan, you could be adding debt to what you currently owe from your previous loan. Or you might set up your new one with a shorter or longer repayment period, depending on your needs and ability to repay the loan.
Why do you want to refinance your business loan?
What is your goal for refinancing? Common reasons include saving money in the long run, extending payments with smaller payment amounts, consolidating several debts, or making fewer payments throughout the year. Whatever your reasons are for refinancing, crunch the numbers yourselves or seek help from a professional.
Pros
Better Interest Rates
With a better interest rate, a business could substantially save money in the long term. At the end of the loan term, a lower interest rate can save tens of thousands of dollars or more depending on the size of the loan.
More Cash on Hand
More cash on hand would be available if your loan payments are smaller. That money could be reinvested into the business through expanded staffing, upgrades, newer equipment, or more efficient high-tech systems and computer software. The owner could also spend that extra cash toward a retirement fund or even a long, dreamt-of getaway vacation.
Lower Servicing Costs
With a higher cash flow, you would be paying less on your debt servicing. That would increase your debt service coverage ratio, which is a ratio of operating income available to debt servicing (interests, principal, and lease payments). When the ratio is higher, it becomes easier to get a loan, and you could be approved for a larger amount.
Cons
Hard Credit Inquiry
As with any loan, the lender would make a hard credit inquiry to check your credit history and score. Luckily, your credit will only show one hard inquiry regardless of how many lenders check it in a certain period of time, between 14 and 45 days. The credit reporting giant, Experian, reports FICO’s window is 45 days, while VantageScore has a 14-day window. Otherwise, shopping around for the lowest lender would destroy one’s credit.
However, your credit would show a hard inquiry, which slightly lowers your credit. And after the refi takes place, the average age of your credit would also take a hit causing your score to lower even more. You just have to decide if the small hits are worth it or not.
Collateral
Lenders will sometimes require collateral for a loan, even if it’s a refinance. That way, if they don’t get paid, they can seize the assets that are used as collateral as a guarantee they won’t lose as much as the entire unpaid debt. A borrower needs to understand that an unforeseen event could be serious enough to prevent the borrower from repaying the loan. In that situation, the asset used as collateral will be seized by the lender.
Prepayment Penalty
Some lenders charge prepayment penalties if you pay off the loan earlier than the term of the loan, so you could try to find a lender that does not charge for prepayment. The SBA, for example, charges a minor prepayment penalty when someone prepays during the first three years of a 15+ year loan.
Costs of a Refinancing Loan
When someone only looks at a lower interest rate as a reason to refinance, that option can seem extremely attractive. But don’t forget there will be other costs incurred as well. Closing costs associated with a refinance can be anywhere between 3% – 6%. Other fees include an origination fee, underwriting fee, SBA guarantee fee, and a late fee for overdue payments. And if your lender charges prepayment penalties, then that would be another cost to you, the borrower. Still, when you crunch the numbers or have someone do that for you, a refinance still could be a beneficial and logical choice for your business.
The Best Time to Refinance
Refinancing is the process of setting up an alternative way to pay off your debt in a more advantageous manner due to certain factors including changes in rates or your income situation. Refinancing a business loan does come with a cost – additional debt – so one has to be careful that refinancing is the right choice. Just because you are refinancing doesn’t necessarily mean your debt will disappear more quickly. You don’t want to go bankrupt because of the added debt.
Refinancing a business loan can be a good choice if interest rates have dropped substantially as they have in recent years. Other than lower interest rates, there are several reasons that could make your business eligible for better rates and terms. Just the fact that you have been paying your current mortgage on time for several years shows lenders you are willing, reliable, and likely to pay off your debt. If your credit score is higher, that can be a reason to offer your business better terms. If your company has increased its revenue and has shown to have a healthy financial status, you would likely receive better rates. Before you make up your mind to refinance, just be sure your savings from the refinance loan are greater than the cost of a refinancing loan.