Refinancing is when you replace an existing loan with a new loan that pays off the old loan. When you refinance a business loan, you’re taking out a new loan, then immediately use the funds you received from that loan to pay off the old debt.
If you are considering refinancing a business loan, the new loan should always have better terms than existing. The main features of any loan are the loan amount, the interest rate, the term, and collateral. If you think that your existing loan does not meet the financing needs of your business or you think you can get a better deal that would bring you benefits in terms of any of your existing loan features, it may be a good idea to consider refinancing.
You can refinance an existing debt either with the same lender or with a new one. However, before making the final decision, you should give thorough consideration to all available options. Refinancing will have costs, so you need to weigh the benefits against the costs and see if it makes sense to refinance the debt. Also, in our loans for SMBs section, you can find various suitable options to refinance your debt.
Why Refinance? The Benefits of Refinancing
There are multiple benefits of refinancing debt, and going through each of them will help you define the refinancing goal you want to achieve. You may want to consider refinancing:
- If you can get lower rates
Sometimes your business grows and develops, which gives you a better credit profile based on which the lenders will be willing to loan you money at lower rates. So if your business experienced marked improvement or you hit a significant milestone, you may want to leverage your better personal or business credit score and refinance your existing loans as these improvements should be reflected in your financing costs.
You should talk to your bank or other potential lenders and see if the improved financial profile of your business can get you a better deal. This improved profile may also come from collateral with which you can support your loan: a real estate or a piece of equipment that you acquired since taking out the old loan.
Also, if market conditions changed after you took out the old loan, and the general level of interest rates decreased, your loan would likely get a lower rate too.
Whatever the reasons, you should contact both your existing lender and other potential lenders and check if you can get lower rates on the type of financing that your business needs. - If you can get better terms
The term of a loan is another important feature because it impacts the amount of your monthly payments and the total amount of interest that you will pay over the term. With the longer-term (and keeping all other features unchanged), your monthly payments will be lower, but the total interest that you pay over the term will be higher. Depending on your business needs, you may choose what you value more – lower payments or lower total interest paid. If you think that you can change the term so that it better fits your financing preferences, you may look into refinancing your old loan. - If you can get a larger loan (and you need it)
If you have additional financing needs that go beyond your existing loan, you can consider refinancing. - If you can consolidate your debt
If you have multiple forms of debt each with different features, it may be a good option to consolidate them all into one single more manageable loan. Instead of a mix of daily, weekly, and monthly payments, you will pay just one lender on one schedule. This could prove particularly beneficial if you bundle up your expensive debt like short term loans, credit cards/credit lines or merchant cash advances and replace them with one loan with more favorable terms.
What Else Should You Consider Before Refinancing?
Before making a decision about refinancing a loan, you should consider the prepayment costs of your existing loan because with refinancing you essentially use funds from the new loan to pay off the existing debt in total before the term.
These costs are charged because lenders are losing out on the interest they expected to accrue throughout the full life of your loan. These costs will be outlined in your loan agreement.
The net benefit of refinancing will determine whether refinancing will make financial sense for your business. You will arrive at the net benefit when you compare the dollar amount you can save by refinancing with the dollar amount you need to pay as prepayment costs and other fees that either your old lender or your new lender may charge.
What are the Risks and Why They Matter?
There are multiple benefits from refinancing as, if all options are carefully considered, refinancing can save a lot of money to your business. However, care should be taken not to refinance one expensive loan with another similar product just to extend the payment schedule as this can cause more problems in the future as you can get stuck in a vicious cycle of expensive debt.
If this is the case, you may want to take a closer look at your business and identify the reasons behind these developments and see if there are other things you can do to make the debt payment more manageable like cutting on non-essential expenses or working on improving your cash flow management by better managing account receivables and payables or better inventory management to free up some cash.
In a Nutshell
In general, refinancing should be seen as an option to replace a more expensive debt with a less expensive one. That is the sure way you will get benefits from refinancing as other options like replacing expensive debt with another expensive debt may only offer temporary relief, but in the long run, it may bring more problems unless something considerable is changed in your business and it becomes more profitable.
Look at how your financial profile has changed since your last loan and see if there is room to renegotiate better conditions with the existing or a new lender. Make sure you factor in all the benefits of refinancing as well as all associated costs which might stem from the old loan(s) like prepayment penalties or the new loan like origination fees.
