Maybe your business loan's terms worked well initially, but you're now in a better financial position. Or maybe you agreed to less favorable terms because you needed fast access to capital.
No matter your reason, the idea of refinancing business loans and obtaining a more manageable payment plan is attractive to most business owners. If you're considering refinancing, you need to understand the ramifications before signing on the dotted line.
What does it mean to refinance your business loans?
When you look into refinancing, your general goal is to make your debt less expensive or easier to manage. This can mean securing a better annual percentage rate (APR), longer repayment period or lower payments.
With a refinancing, you'll pay off your original loan in a lump sum and take on another loan with more favorable terms.
Why would you refinance?
Business owners refinance to obtain a better business loan. The best business lenders don't want you to drown in debt; they make money when you repay the loan, not if you default on it. For this reason, more manageable terms could benefit both lenders and business owners, especially if it means the borrower is more likely to make timely payments.
Some business owners may seek to refinance to consolidate their debt. If multiple debt sources are dragging you down, consolidating your loans into a single source through refinancing can make your financial obligations more manageable.
Types of business loans that businesses might refinance
There are several options for refinancing a business loan.
- Refinancing business debt with a bank loan: Consolidating or refinancing your business debt through a bank loan may provide a lower interest rate. This type of refinancing is a great way to avoid a balloon payment.
- SBA refinancing: An enhanced Small Business Administration (SBA) business loan is a beneficial financing option for small business owners because of the low interest rates and low down payment requirements. There are a few different SBA loan programs to help refinance your business debt. For instance, an SBA 7(a) loan can refinance your existing business debt as long as your new loan has the same security as the previous debt. SBA 504 refinancing is an option for eligible small businesses that are planning an expansion.
- Alternative loans: If you think you might struggle to qualify for bank loans or SBA refinancing, you can seek refinancing from alternative lenders. Alternative loans include business credit lines and merchant cash advances. For information about an excellent business credit line lender, read our review of Fundbox.
- Term loans: If you're looking to refinance a business loan to shorten your loan payment term, some private lenders offer highly flexible terms. SBG Funding is a great example (read our SBG Funding review for more information). Similarly, lenders like Fora Financial specialize in short-term loans you might be able to use for refinancing. Read our Fora Financial review for more information.
- Equipment loans: If you took out a loan to purchase equipment, refinancing through a business equipment loan is possible. Our best pick on this front is Crest Capital, given its fast funding and low interest rates. Read our Crest Capital review for more information.
- Microloans: By definition, microloans are small, so they're a great option if you're refinancing to lower your loan costs. After all, 57% of small businesses seek loans under $100,000, according to the Federal Reserve Banks. An excellent microloan provider is Accion, thanks to its flexible terms and unique educational resources. Read our Accion review for more information.
Costs and fees associated with refinancing
Like all loan types, refinancing comes with costs and fees. Below are some costs and fees you should know about and their percentage of the total loan amount.
- Closing costs: 3% to 6%
- Underwriting fee: 1%
- Origination fee: 1% to 5%
- SBA guarantee fee: 2% to 3.5% (of guaranteed amount, not total loan amount)
- Prepayment fee: 0% to 2% for non-SBA loans; 1% to 5% for SBA loans with loan repayment terms longer than 15 years
- Late fee: 3% to 6%
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Important things to know before you attempt to refinance
Think you're ready to refinance? Before you go forward, make sure you understand the following.
1. Not all lenders allow refinancing.
Before you apply for a better loan, make sure the original business loan terms include the ability to refinance. Not every lender permits refinancing, so double-check that you can.
2. Your business's vital signs matter.
The terms of your loan are based on your business credit score, revenue, time in business, cash flow and other indicators of your company's financial health. You can think of these as vital signs. Have they improved since the last time you borrowed money? If they haven't, you might want to wait until you are in a better financial situation to apply for refinancing. Remember that lenders assess your risk as a borrower. If you haven't proven to them that you're a low-risk candidate, you're less likely to find more favorable terms.
3. Know what you want to accomplish with refinancing.
What are you seeking when you speak to lenders? Do you want to find a loan to lower your monthly payments? Are you hoping to extend your current loan's term? For instance, are you looking to convert a short-term loan to an SBA loan? All of these goals are different, and all will help your business. However, the best refinancing opportunity for you should align with your business goals.
4. Know your loan's current terms.
Do you know all the ins and outs of your current loan? Do you know the interest rate you are paying? Do you know how much principal and interest you have left to pay off? How is your loan structured? Does it amortize? You get the gist. You can't find the best refinancing terms to suit your business unless you understand the situation you're in now – and the one you want to get to.
5. Not every offer is worth it.
Just because you get an offer to refinance your loans doesn't mean you should take it. Refinancing is a long process, and it's worth it for the right offer. But if refinancing doesn't make a big difference for your business, such as making your monthly payments more manageable or giving you access to working capital for a longer period, it might not be worth the trouble. You could be better served by waiting until your financials improve and then reopening your search for solid offers.
How to qualify for a business refinance loan
No two lenders will have exactly the same qualification terms for business refinancing. That said, the notion of a "good borrower" typically comprises the same traits, regardless of lender:
- Good business and personal credit history and credit score
- No recent bankruptcies
- No outstanding tax liens
- Certain number of years in business
- High annual revenue with minimal fluctuations
If these traits don't quite describe you, don't fret; you can still pursue refinancing. You just might need to sign a personal guarantee. This means the lender can seize your property to repay your loan if you can't cover it with cash.
Pros and cons of refinancing a business loan
Like most business endeavors, refinancing a business loan has pros and cons. Consider these factors before taking out a new business loan.
Pros of refinancing a business loan
- Lowering the loan payment can help free up cash flow within the business, allowing you to invest the extra funds into payroll, inventory, new equipment or other business needs.
- Refinancing a business loan often means you receive a better interest rate and more attractive loan terms, which can save you money in the long run.
- If the loan refinance will improve your cash flow, some lenders may approve you for a larger loan based on your debt-to-service coverage ratio. A larger loan may eliminate the need for additional loans.
Cons of refinancing a business loan
- One of the worst things that can happen when you refinance a business loan is a negatively impacted credit score, as refinancing will reduce the average age of your credit. If your score is already low, you may not qualify for refinancing.
- You may incur prepayment penalties for paying off the original loan early, which may reduce the savings you would have earned with refinancing.
- Some lenders may require collateral as security for the new loan, even if you didn't put up any to secure the original financing.
Meredith Wood contributed to the writing and research in this article.