Often, when businesses take on their first debts to cover startup expenses or assist in financial emergencies, they get stuck with a loan that has undesirable terms. Businesses in the early stages usually haven’t built any credit and don’t have long-standing financial proof of concept, making them seem risky to some lenders.
If financial straits ever compelled you to take on subpar debts or if you’d like to consolidate several financing products into a single monthly payment, then refinancing may be a good option for you.
What does it mean to refinance business debts?
Refinancing business debts, put simply, is the process of finding a new loan with better rates to pay off existing debts. According to Forbes contributor Jared Hecht, “When you refinance a loan for your business, you’re effectively taking out a brand new loan, then immediately using the capital you obtain from that loan to pay off your previously held debt.”
“Most often,” he continues, “small business owners use loan refinancing to replace expensive short term loans with a longer term, lower cost loan product, such as a multi-year term loan or an SBA loan.”
The benefits businesses hope to gain from refinancing include:
- Reduction in monthly payments
- Reduction in total APR
- Reduction in total cost of capital
- Enough additional capital to avoid further loans
- More convenient payment schedule
When looking for refinancing options, it’s important to keep in mind the potential benefits your business seeks. Refinancing has the potential to increase your monthly cash flow by decreasing payments. Done improperly, however, refinancing can actually increase your financial burden.
You’ll need to work through a few considerations to ensure refinancing is a viable solution for your business:
Understanding Your Current Business Debts
Some of your old loans may have prepayment penalties. These penalties are essentially an attempt by lenders to recoup some of the interest they’ll lose when you pay the balance of your loan early. You’ll have to look through the fine print of your existing loans to discover whether you’ll face a prepayment penalty if you pay them off early.
Prepayment penalties aren’t necessarily a nail in the coffin for businesses looking to refinance. When doing your calculations, if you add the prepayment penalty to the total of your debts and find that a refinancing option will still lower your monthly payments despite the added expense, it may be worth refinancing after all.
You should know these details for each of your existing debts:
- Current remaining balance: total payoff amount of your current loan(s)
- Current monthly payment
- Interest rate and APR
- Remaining repayment term: number of months remaining on your loan(s)
- Repayment frequency: do you make monthly, weekly, or quarterly payments?
- Prepayment penalties
With this information in front of you, it should be easy to decide which financing option will work for you.
Limitations to Finding Suitable Refinancing Options
Listed below are some factors that will limit your ability to find a good refinancing option:
- Bad credit score: especially if your score hasn’t improved since taking on your original debts
- Recent bankruptcy filing
- Outstanding tax liens
- Young business: if your business isn’t much older than when you took out your original debts, your chances of getting better terms decrease
- Unable to meet annual revenue requirements
In short, if your business is in the same state as it was when you originally took on debt, it’s unlikely you’ll find better terms. Thus, the timing of your decision to refinance is crucial. You want to refinance when your credit score is stronger and your revenues are steady to drastically increase your chances of finding better terms.
Using an SBA Loan to Refinance
Refinancing with loan products like term loans and business credit cards is pretty easy. Especially if you use an online lender. Using an SBA loan to refinance, on the other hand, can be a little tricky.
Why would you want to finance with an SBA loan? Well, SBA loans are government-insured so they generally have good terms. Here’s what the SBA says about refinancing current debts with an SBA loan:
“It is possible to refinance loans that small businesses have outstanding with the SBA 7(a) loan program. Basic requirements include that the purpose of the original loan(s) would have been SBA eligible. The proposed loan needs to provide the borrower with a substantial benefit demonstrated by the payment amount being at least 10% less than the existing loan.”
Refinancing Can Improve Cash Flow and Simplify Your Life
Successful refinancing of your debt will reduce your monthly payments and consolidate your debts into a single payment, reducing your stress and giving you more time to focus on building your business. If the timing is right, refinancing can be a no-brainer.