For small business owners, cash flow matters every bit as much as the long-term potential for profit, growth, and expansion. After all, achieving the latter may never become possible without the presence of the former.
And entrepreneurs who have already taken the common step of getting a small business loan to aid in the cash flow of operating their company may reach a point in time where they wish to refinance their original loan.
Why? Perhaps, it is the draw of a lower interest rate than what they were able to secure initially. This translates into lower monthly payments and, again, can enhance a small business’ cash flow.
Whatever the reason, there are many things for business owners to pay attention to when it comes to refinancing a business loan. In this definitive guide, weâll take you through each one so you can be fully prepared when itâs your turn to consider this option.
What is Small Business Loan Refinancing?
Refinancing a business loan entails taking an existing loan that has a balance outstanding and replacing it with a new loan, whether for reasons of better rates or more appealing terms. The new loan, in effect, enables the applicant to pay off the initial loan and to gain the advantages that come with the new loan (for instance, a lower rate).
When a business or person revises the interest rate, payment schedule, and terms of a previous credit agreement, that is considered refinancing existing debt. A small business owner seeking to optimize existing business debt by replacing the terms of an existing debt with a loan that has better terms, instead of debt consolidation, is opting to refinance.
Getting approved for credit over a longer term than the initial loan would reduce one’s monthly loan payment, or enable the business owner to retain a monthly payment comparable to his current monthly payment while taking out a larger principal amount. In this instance, the applicant is borrowing a greater amount of money. If you end up with an interest rate on a new loan that’s lower than the rate the first time you borrowed money, you will end up saving money in the long run because the amount of accrued interest would not be as high.
How to Refinance a Business Loan
If you were initially approved to borrow money over a 10-year period at a rate of 10%, and you see that current market rates are considerably lower than they were when you were approved for the first loan, you might be tempted to apply for a new loan at the lower rate, say 7%. If you are able to locate a financial institution or lender who will work with you, you could refinance business debt with a new loan application. If you are approved, you can use that new and better loan to pay off the current loan.
A small business owner might qualify for a new, lower interest rate if he or she has established good, or improved, credit since the time that the money was initially borrowed. If your business credit report has shown significant improvement, there’s a chance that you’ll qualify for refinancing options with a lower interest rate because your financial history has improved. Businesses that have a variable rate loan with an upcoming balloon payment may also opt for refinancing their loan.
Refinancing could also enable a small business owner to locate a loan with repayment terms and fees that are more favorable for their business. Refinancing business loans could be a way for an entrepreneur to make less frequent payments, or to shorten the overall loan term, paying off debt in an accelerated time period.
Advantages of Refinancing a Small Business Loan
Lowering ongoing financing costs:
When a small business owner refinances a loan with a reduced long-run cost, then more money each month becomes available to meet other business needs.
Improved cash flow:
While the ultimate goal of any business is profit and growth, the short-term benefits of cash flow are vital to the company’s operation and even to its very existence. Steady cash flow accounts for the expenses necessary to keep the company running on a daily and monthly basis, including rent, payroll, and inventory. Refinancing can boost a company’s cash flow, saving money with reduced monthly costs or creating additional cash for other projects, so incoming funds do not have to be directed at paying off these expenses.
Increased funding amounts:
Refinancing a loan gives a small business a chance to borrow additional cash. Often, lenders will provide more financing to a business that has shown a successful track record, and so refinancing can be one of the ways to secure that extra capital. How that cash is used depends on what a business’ biggest financial needs are and what the loan terms and conditions allow.
Disadvantages of Refinancing a Small Business Loan
Your credit score could be impacted:
Refinancing a loan might result in a hit to an applicant’s personal credit score. The application process can be like an invasive exam, and credit bureaus can be pretty unforgiving in these circumstances. Taking out a second loan can also increase one’s total amount of debt, which isn’t the best thing for one’s business credit profile.
Prepayment penalty fees might result when someone borrowing money pays their lender all or part of the loan principal prior to its due date. A company pays off its previous loan debt with the funds from its new loan when refinancing, so if there are prepayment penalties on the first loan, you could be smacked with prepayment fees. In this case, the small business owner seeking a second loan must measure the ultimate cost of these prepayment fees against how much he’ll save by refinancing.
Owners of small businesses are required to name some amount of collateral when applying for a loan. If your business credit score has gotten worse since you applied to borrow money the first time around, collateral might be required for refinancing a loan. You might also not qualify for a refinance if your business circumstances have changed, so you must treat the application with as much respect as you did on the original financing request to have a good chance of being approved.
Do You Qualify for Refinancing?
Many of the same variables apply to who qualifies for refinancing as they do to who would qualify for a small business loan in the first place.
Equity: Have you paid off at least 20% of the first loan you took out? If you haven’t, it’s a lot less likely that you’ll be able to find a lender who’ll approve you to borrow more money for your business.
Income: Is your small business making money? If a company is generating income, there’s a much better chance of getting approval to refinance.
Credit score: Has your credit score gone up since you originally borrowed money for your business? If it has, the chance for refinancing approval is much better than if that credit score hasn’t improved, or, especially, if it has taken a hit since the first loan.
Existing debt: How much debt does your business have? The more debt, the worse off your chances are for getting approved for a second loan.
Financial history: Banks are going to look for whether a loan applicant is making monthly payments on time. How often do you borrow money? What kind of credit have you employed in the past? The more sound one’s financial history has been, the more favorably a lender will view a loan applicant.
What Kind of Commercial Loans Can be Refinanced?
Business term loans
A lump sum of capital that is paid back with regular repayments at a fixed interest rate, a business term loanâs repayment term length can range from a few months to several years. A âbusiness term loanâ usually refers to financing with terms ranging from one to five years to pay off.
An entrepreneur often uses the proceeds of a business term loan to finance specific investments for their company, such as debt refinancing, business expansion, or real estate purchases.
Banks and online lenders can both provide loan programs for business financing, but term loans can be a challenge to secure. They may involve a lengthy, arduous application process without a high rate of approval. Applying for a term loan in the online marketplace rather than in person at a bank is another option a business owner might consider.
A term loan may require collateral and a demanding approval process to reduce the risk to the lender that the borrower may default on the loan or fail to make payments. Term loans usually do not carry any penalties provided they are paid off ahead of schedule.
Working capital loans
A government agency that provides support for entrepreneurs, the United States Small Business Administration (SBA) backs small business loans issued through their lending partners to help lower financing rates for business owners. The SBA also can help entrepreneurs to qualify for loans for working capital. The SBA has a loan program with the purpose of making access to capital more attainable for business owners. Featuring low down payments and interest rates that are below market rate, the SBA 504 Loan Program allows small and medium-sized businesses to invest in their facilities and expand their reach, giving them more stake in their community. The SBA 504 program was developed with the intent of aiding small businesses in the creation of wealth.
Working capital financing secured through the SBA usually mean a larger selection of loan sizes, repayment terms that are lengthier, and interest rates that are not exorbitant. Other means of short-term funding options usually don’t offer annual percentage rates as low as SBA loans.
SBA loans require a lot of paperwork, with a considerable amount of applications to fill out. Approval also will depend heavily on the applicant’s business history and credit score. But if you are willing to deal with all the red tape that goes with applying for an SBA loan, the upside is markedly lower financing rates and generous lengths of time to repay the loan than is the case with other loan options.
The length of an SBA loan can range from between five and 25 years. Although loans backed by the SBA give small business owners more access to financing, those loans still are competitive.
An equipment loan is secured by the equipment itself. A business that can’t afford to pay off the loan would end up surrendering the equipment as collateral.
If cash flow impedes the purchase of vehicles or machinery, small businesses can turn to small equipment loans to finance the heavy-duty parts they need to make a go of things. Several providers ranging from traditional banks to alternative lenders are available to lend money for equipment. The rates for an equipment loan could be anywhere from 6 percent to 9 percent.
Businesses must come up with a down payment of between 10 and 30 percent in an equipment loan agreement. The lender will finance the remainder.
When a business’ equipment starts to wear out or become outmoded, and the company still needs that type of equipment to operate at maximum efficiency and productivity, then the business needs new equipment and a way to pay for it.
A small business operating on a limited budget may see financing equipment as an attractive option to preserve its cash on hand by dispersing the funding of needed equipment over several months or years in predictable, equal payments.
Commercial real estate loans
A business owner might decide to purchase either a new commercial property or an existing piece of commercial real estate. A commercial real estate loan is a mortgage loan that is secured by a lien on the real estate that is being purchased, not on residential property. A lien is a legal right granted by the owner of property, granted by a law, or otherwise acquired by a creditor. Once acquired, this lien serves to guarantee an underlying obligation, such as the repayment of a loan.
Commercial lending can enable a business to expand via the acquisition of additional commercial property. There are six types of commercial real estate loans: SBA 7(a) loans, CDC/SBA 504 loans, traditional commercial real estate mortgages, commercial bridge loans, hard money loans, and conduit/CMBS loans.
The profile of an applicant for a commercial real estate loan is a business owner who has a good credit history (680 personal credit score or better), annual revenue of at least $250,000 and a company that has been in business for several years.
Alternative lenders might be a worthwhile option for entrepreneurs to consider. Small loans that come from individual lenders, not from a bank or a credit union, microloans can be issued by an individual or they can be assembled from several lenders each contributing a given amount until the necessary funding total is achieved.
With a microloan, the lender gets interest on the loan and repayment of principal after the loan has reached its full term. Microloans come with interest rates that are above market, so some investors may be attracted by that aspect of them.
Business lines of credit
Sometimes a business line of credit can be approved in as little as 24 hours or less. Depending on the lender, you might only need a credit score of 500 to qualify for a business line of credit.
When a lender provides pre-approved funding with a maximum credit limit, that is known as a business line of credit. If the borrower is approved for this line of credit, funds can be accessed whenever they are needed until the established credit limit has been reached.
Because the borrower is only paying interest on the amount that he or she withdraws, a business line of credit can be advantageous for business owners who are uncertain of the amount of funding they will actually require, or when they might need it.
The drawback to a business line of credit is that the loan will be at a rate that might be considerably higher than other types of loans. How costly that would be is heavily dependent on the amount of funds the entrepreneur ends up using.
If a business owner needs to establish a favorable credit history, a business line of credit could help him or her do that.
Get The Benefits of Refinancing Business Loans
Having adequate cash flow is an essential part of owning a successful small business. By refinancing a business loan, you can reap a number of benefits that can ultimately lead to more cash flow. From decreased intereste rates to lower monthly payments, refinancing a loan can help you secure the cash that you need to continue operating a thriving business. It can always be a good idea for you to speak to a financing specialist about your businessâs specific needs and how to refinance a loan that you are currently paying back. There are funding specialists at Biz2Credit who can help you unpack this if you need it.