5 Things to Consider Before Refinancing Small Business Debt

5-Things-to-consider

Original article posted on FitBizLoans.com

If you’re struggling with a high interest rate or high monthly payments on a business loan, you may be able to replace the existing business debt with a new, more affordable loan. This is called refinancing. Refinancing is also used to consolidate several business loans into a single monthly payment and to avoid high balloon payments on commercial loans.

Before refinancing business debt, ask yourself the following 5 questions.

1. Will I Benefit From Refinancing?

Before refinancing a loan, you should first evaluate the terms of your existing debt and ask yourself, “Can I do better?” In particular, you should consider the interest rate and remaining term on your current loan.

Interest rate on existing debt:

If you currently have an SBA loan or bank loan with interest rates under 10 %, that’s hard to beat. If you have more expensive debt, perhaps from credit cards or an alternative lender, then you may be able to benefit by refinancing with a less costly loan product.

However, in order to qualify for refinancing, something typically needs to have changed since the time you originally borrowed money.

Here are a few examples:

  • Has your personal credit score or business credit score improved since the time you applied for the original loan?
  • Have your business revenues increased since you originally applied for financing?
  • Were you in a time crunch when searching for financing the first time around, which forced you to choose a more expensive loan?

If you answered yes to any of these questions, you may be able to get a better interest rate and lower monthly payments  by refinancing.

Even incremental improvements can make refinancing beneficial. When Michael Zadeh, owner of Zadehkicks, an Oregon-based designer footwear business, was just starting out, many lenders turned him away because he didn’t have a long credit history. He ended up having to get a costly merchant cash advance with an APR of 60 % to help him purchase inventory and grow the business! One year later, after building up a history of timely payments with the MCA, Zadeh was able to refinance the MCA to a 22 % APR term loan from online business lender Dealstruck.

The key is to think about the current creditworthiness of your business and yourself and whether you can qualify for a loan with more favorable terms now than you did the first time around.

Term of existing debt:

Prior to refinancing, you should consider where you are at in terms of paying off existing debt.

For most commercial loans, initial payments go towards paying down interest, and later payments go towards paying down principal. If you’ve already paid down most of the interest on your loan, those are “sunk costs,” and you may not be able to save money in the long term by refinancing.

However, if your main reason for refinancing is to lower your monthly payments, then it may make sense to refinance even if you’re in the tail end of your current loan term. Refinancing to a loan with a longer term will make your monthly payments more manageable. For instance, if you have a 5-year loan that’s set to reach maturity soon but you’re struggling with the monthly payments, you can lower those payments by refinancing with a 10-year SBA loan.

2. Do the Fees Make It Worthwhile to Refinance?

Small business owners should keep in mind that it’s not free to refinance business debt, and at times, the fees can make it prohibitively costly. Fees may include an origination fee, application fee, lender fee, appraisal fee (if commercial property is involved), and a prepayment penalty that applies if you refinance again before the loan is paid off.

For example, many business owners choose to refinance existing debt with an SBA 7(a) loan. Business loans subsidized by the U.S. Small Business Administration (SBA) have the lowest interest rates on the market. However, fees and closing costs can constitute 4-8 % of an SBA loan. If the fees are higher than what you would save by refinancing (i.e. through lower monthly payments), then it may not be wise to refinance right now.

Going to the lender that issued the original loan gives you some leverage to negotiate lower fees or have them eliminated all together. In addition, most fees can be either paid upfront or rolled into the loan.

3. What Is My Reason(s) For Refinancing?

There are numerous reasons that lead small business owners to refinance:

Lower Monthly Loan Payments

You can lower your monthly loan payments by refinancing to a lower-rate loan or longer-term loan. Remember that you need to have good credit (above 600) in order to qualify for an SBA loan or ordinary bank loan. Those with lower credit will have to seek out alternative loans. Whether you qualify will also depend on other factors, such as your business revenues, how long you’ve been in business, and how much collateral (if any) you have. Requirements vary based on the lender.

Consolidate Multiple Business Loans

Carrying multiple sources of business debt can be a good reason to refinance. For example, sometimes people rack up debt on a bunch of credit cards. If you have good credit (above 600), you can refinance outstanding credit card balances into a lower-rate peer2peer loan or bank loan.

Avoiding An Upcoming Balloon Payment That You Can’t Afford

Commercial real estate loans and other large business loans are often structured as balloon loans. This means that the lender will review these loans every 5-10 years, either extending the loan at that point or requiring the outstanding balance to be paid in full in a balloon payment. If you can’t afford the balloon payment, you may need to refinance.

Switch Out a Variable Rate for a Fixed Rate

Some business loans, especially bank and SBA loans under $100K, tend to have variable rates. This means they are tied to a market rate. While market rates are currently at a historical low point, they can increase. If you’d rather have the guarantee of a fixed rate and a fixed monthly payment, you can try to refinance to a fixed rate loan.

Cash-Out Refinancing

Normally, when you refinance, you replace the existing business debt with a new loan for the same amount. With cash-out refinancing, you trade in the existing business loan for a larger loan.

You put the difference back into your business to purchase inventory, remodel, hire employees, expand, etc. The advantage of cash-out refinancing is that it can help your business grow long term. The downside is that you’re stuck paying back more debt than your started with.

In most cases, cash-out refinancing is available only for commercial property loans, and you must have significant equity in the property.

4. How Can I Find a Lender To Refinance My Loan?

Finding a lender for refinancing is not that different from finding a business loan in the first place. At FitBiz Loans, we have helped many business owners refinance their debt. Answer just a few questions to get started.

The cheapest option is generally to go to the lender that issued the original loan and see if they will refinance your business debt. The original lender is more likely to waive any fees associated with refinancing.

It’s wise to avoid the situation that led to the need to refinance in the first place. For example, many banks offer balloon loans to clients who are looking to refinance, but that may lead you to have to refinance again.

If you have bad credit, refinancing may not be an option. If you’re struggling to pay off an existing loan and have bad credit, a better course of action is to contact the lender and see if they can work out a payment plan with you.

There are specific rules for refinancing with an SBA loan. Ricky Navarro, Senior VP and Director of SBA Lending at Marquis Bank, says the rules come into play when you want to refinance existing non-SBA debt into an SBA loan.

You can refinance into an SBA 7(a) loan, says Navarro, as long as the original purpose of your debt is eligible for a 7(a) loan and refinancing will rid you of a balloon/demand payment or lower your monthly payments by at least 10 %. These rules exist because the SBA wants to ensure that the new loan will improve your business’ cash flow.

In most cases, you cannot refinance existing non-SBA debt into an SBA 504 loan, which is used to finance real estate and other fixed assets.

If you don’t meet these requirements, one way to get around the rules is to simply get an SBA loan, put the proceeds in the business as working capital, and use the resulting business profits to pay off the existing debt.

5. Will Refinancing Affect My Credit Score?

When you refinance existing debt, the old loan is typically closed out, and the new loan will show up on your credit report. Older, established debts are considered more valuable than new ones, so your credit score could get dinged. Moreover, the new loan is a new credit obligation, which can also lower your score.

Keep in mind that shopping for a new loan may trigger hard credit pulls, which can temporarily lower your credit score by a few points. You can decrease the number of hard inquiries if you rate shop during a 14-45 day period.

Bottom Line

Refinancing is a good way to save money when you are facing a high interest rate or high monthly payments on existing debt. Just be sure to realistically evaluate the terms of your existing debt and whether you can benefit by refinancing.