For many small business owners, business loans are critical to financing company growth and development. The savviest entrepreneurs keep their eye on the market and monitor for opportunities to score better loan interest rates or find payment terms that better match company needs. The process of refinancing a business loan is similar to the process of initially obtaining one – There is a lot of waiting and plenty of paperwork required. However, the work involved is often more than worth it for small businesses that want to make smart financial choices and support progress. Wondering if it might be time for you to refinance your business loan? Read on to find out.
How Refinancing Works
Refinancing a loan actually means getting a new business loan that pays off the current debt on your existing loan. There are several reasons why a business would consider refinancing a loan. The most common include:
- Lower annual percentage rate (APR): Interest rates change depending on the market and the economic climate. Rates may go down significantly during the period of an existing fixed-rate loan. Business debt refinancing can help you achieve lower rates and save money on interest payments and fees. Additionally, if your business credit report improves significantly over time, you may be able to get a better rate if you refinance because of you improved financial history. Refinancing is also a common option for businesses that have a variable rate loan with an upcoming balloon payment.
- Lower monthly payment obligation: A refinance is based on the remaining debt on your current loan. This amount will be less than the original loan amount. Because of this, periodic payments can be smaller. Additionally, lower interest rates can decrease your monthly payment obligation.
- Less frequent payments: Refinancing allows you to find a loan with repayment terms and fees that might work more favorably for your business. By refinancing, you may be able to make payments less frequently or even shorten the overall loan term, paying off your debt in an accelerated time period.
Benefits of Refinancing a Small Business Loan
Refinancing can have a positive impact on a business in many ways. Some of the most meaningful effects include the following.
- Reduced cost of financing: Financing cost reflects the total expenses associated with securing funds, such as interest, fees, and other charges. When a business refinances a loan with a reduced cost, it frees up money on a monthly basis that can be used to meet other business needs.
- Better cash flow: Cash flow is the heartbeat of a business. It pays for the expenses that make your business run, like rent, payroll, and inventory. Refinancing can improve cash flow by saving a company money with reduced monthly costs or by providing additional cash for other projects, so incoming cash does not need to be diverted to these expenses.
- Increased funding amount: It’s no secret that simply having more money can sometimes make a positive difference for a business. Refinancing a loan typically provides the company with an opportunity to borrow additional cash, which they can allocate as needed, whether that’s to fund a large investment to improve processes within the business or just to catch up on outstanding bills.
Drawbacks of Business Loan Refinancing
- Impact on credit score: Refinancing a loan can cause your personal credit score to take a small hit because of the hard inquiries with the credit bureaus that occur as a part of the application process. Additionally, refinancing a loan can increase your debt, which can impact your business credit profile.
- Prepayment penalties: Depending on your lender, prepayment penalty fees can occur when a borrower pays its lender all or part of their loan principal before its due date. In the refinancing process, a business pays off its previous loan debt with the funds from its new loan. Therefore, if your existing loan has prepayment penalties, you will be subject to prepayment charges. Sometimes, these fees are negligible compared to the savings of refinancing. It’s important to examine the exact fees for you unique loan.
- Collateral requirement: If your business credit score has decreased since your initial loan application, you may need to provide collateral for a business loan refinance. Additionally, if your existing loan included collateral as a guarantee, those terms will likely segue into your new loan unless there’s been a major positive change in your financial situation.
Types of Commercial Loans You Can Refinance
Almost any type of loan can be refinanced. Following are a few of the most popular types of business loans that entrepreneurs may refinance.
- Business term loans: A term loan is a standard loan in which a borrower receives money from a lender and pays back the debt in increments (these could be daily, weekly, or monthly depending on your lender) over an agreed-upon timeframe. These loans can last from a number of months to 30+ years, so they work for both short-term financing and long-term financing needs.
- Working capital loans: This class of loan is intended as short-term debt to fund a business’ short-term operational needs and everyday operations. A government CDC loan would fall into this category. For example, a company could apply for a working capital loan if cash is needed during a slow season. Terms for working capital loans are short, so a refi might be considered if a business finds it needs a longer timeframe to repay the loan.
- Equipment loans: These loans are usually used to purchase the big-ticket equipment a business needs to operate, such as a commercial oven or a backhoe. However, any equipment used to do business can be considered equipment—even computers or a restaurant’s pizza oven. Equipment loans use the equipment itself as collateral. Often, businesses must decide whether to purchase or refinance new equipment.
- Commercial real estate loans: A commercial mortgage is similar to a personal loan mortgage on a residential property. Instead, it is a mortgage secured by a lien on a commercial property. Commercial property is defined as income-producing real estate used for business purposes.
- Microloans: Microloans are a unique type of business financing issued by individuals or specific microlending companies. They are short-term loans with low interest rates for loan amounts generally less than $50,000. Entrepreneurs may use these loans to launch or grow an emerging business.
- Business lines of credit: This is a unique type of loan that gives a business a defined borrowing limit. The business can borrow money as needed at any time up to that limit. The business pays back only what is used and just pays interest on the borrowed portion. Often, business credit cards offer a line of credit, as do traditional banks and credit unions.
Qualifying for Refinancing
The qualifications for refinancing a loan are similar to obtaining a new loan. Refinancing qualifications commonly include factors such as:
- Equity: A rule of thumb is that lenders would like to see that you’ve paid down at least 20 percent of your loan before seeking to refinance business debt. This is especially true if you are pursuing a cash-out refinance.
- Income: Lenders need to know that you have sufficient cash coming in so you’ll be able to make your periodic payments.
- Credit score: If you are seeking a loan with more favorable rates and repayment terms, make sure your credit profile is at least the same or better than when you originally applied. There are a number of sites online that allow you to access free business credit scores, including Nav.
- Existing debt: Lenders want to ensure you don’t have excessive debt.
- Credit utilization: A lender will look at your credit limit in relation to how much you are currently borrowing.
- History: Your financial habits come into focus when seeking a loan. A lender wants to know things like whether you make on-time payments, how long you’ve been using credit, and what kind of credit have you used (e.g., credit cards, cash advances, student loans, etc.)
- New credit: When refinancing a loan, lenders especially want to see if you’ve employed any new debt since your last application.
Steps to a Successful Loan Refinance
Before beginning the refinancing process, get yourself organized to ensure you land the loan package that will be the most beneficial for your company.
- Determine how much you owe: Take a look at your statements and figure out how much you currently owe on your business loan. With this knowledge, you’ll be able calculate exactly what you need to make your refi advantageous. It will also help you shop around online, as loan calculators generally require this dollar figure.
- Gather application documents: This can be one of the most tedious parts of applying for any loan, so it’s best to start early to guarantee you have what you need. Most business loan applications require documents such as recent tax returns, legal entity statements, bank statements, balance sheets, profit and loss statements, and business plans.
- Research and compare lenders: Shopping for an opportunity to refinance online is an incredibly simple process. There are a number of loan aggregators that let you easily compare lenders and their loan program. If you prefer to work face-to-face, you can start by visiting a local bank or credit union for more information on business lending options. Some cities also have special resources for small business owners that may be able to point you in the right direction. NMLS Consumer Access offers an inexpensive service to help you vet financial industry professionals before committing to work with them.
Pay special attention to fees associated with closing costs and other origination fees when you are reviewing refinancing options, as these upfront fees can be costly for a cash-strapped small businesses.
Final Word: Refinancing Business Loans
Refinancing a business loan can be a smart move if a company can score a significantly lower interest rate, lower fees, or loan repayment terms that work better for its unique situation. As with any financial commitment, it’s important to ensure the costs associated with refinancing a loan do not outweigh the benefits. If your business needs cash, but the timing isn’t right to refinance business loans, consider other business financing options.