The Complete Guide to Refinancing Small Business Debt
Although you may not like it, debt is often necessary if you’re running a small business. As the old saying goes, it takes money to make money. What goes unsaid, however, is that if you take money from an outside source, you have to pay it back. With interest.
Money always has to be repaid, but it doesn’t always have to be repaid on your lenders terms. If you’re struggling to repay your business debt, you need more working capital, or your business has hit a point in which you’re eligible for better financing, you might be able to refinance your debt. Depending on your situation, refinancing could save your business a lot of money or grant you significant peace of mind.
Should you consider debt refinancing for your business? Read on to find out!
Table of Contents
What is Debt Refinancing?
Quite simply, refinancing is when a debtor takes out a new loan to pay off old debts. Normally the new loan has better rates or fees in some way, granting your business better payment terms, lower fees, or other benefits.
Here’s an example: a business owner took out a loan of $20K, with a two year term length and an interest rate of 36%; repayments are $1,180 a month. A few months later, after the business has matured, the merchant decides to refinance. This time, they secure a $30K loan with a four year term length, and an interest rate of 12%. Repayments are down to $790 per month, and they’ve attained an extra $10K of working capital.
Lower payments are just one of many reasons to refinance, though. Here are some others:
Better Rates or Fees
You may have discovered that, after taking out a business loan, large repayments are eating into your profits and causing cash flow problems. Or perhaps you’re experiencing the opposite—your business has hit certain milestones and you’re suddenly eligible for better financing options.
Whatever the reason, your business needs a change in rates and fees. Refinancing your debt can make that happen. Should you find a better financing option, you might be able to get lower repayments, longer term lengths, or a lower total cost of borrowing.
If you’re in the midst of repaying a loan, but find that you need more working capital, the last thing you want to do is to take out a second or third loan in addition to the first.
Refinancing is a better option here: get a hold of a loan that offers enough cash to both pay off your first loan and invest in your business.
Do you have to make payments to multiple debtors every month? Many businesses find themselves trying to fix cash flow problems by taking out multiple short term loans or advances (loans with term lengths under two years that are normally repaid via daily payments), over-utilizing business credit cards, or overdrawing their lines of credit, and then discover their expensive debt isn’t sustainable.
Instead of ensuring that you’re paying all those expensive sources, you might be able to knock all that debt out at once with a single long-term, lower cost loan.
Should you do so, you’ll only have to ensure that you’re repaying the single source. Plus, chances are, consolidating all that debt will result in lower payments, freeing up more cash for other reasons.
Should I Refinance?
Most business owners can benefit in some way from periodically refinancing their debt. To get the most for your money, however, you need to take a few things into consideration. Before deciding whether or not to refinance debt, and to find the best option for your business, ask yourself these questions:
How has my business changed since I last got a loan?
Businesses have access to different financing options depending upon a few different characteristics of their business. If your business is under one year old, for example, you’re primarily relegated to expensive short term financing options like merchant cash advances and invoice financing.
Once you hit certain milestones, though, your business suddenly has access to a whole lot more capital.
Among other characteristics, lenders consider these three things when deciding if they can help out your business:
- Time in business
- Personal credit score
- Annual revenue
If your business has made significant advances in any of those categories recently, you might suddenly have access to better financing options. Businesses that have passed the one year mark might find they can refinance short term debt with a longer term loan, merchants making over $100K in annual revenue will find that lenders are willing to offer more money, and so on.
Wondering which lenders you might be eligible for given your current time in business, credit score, and revenue? Skip down to this section for some suggestions.
How close am I to repaying my debt?
Even if you could get access to better financing, merchants close to repaying their debts might benefit from just waiting it out.
Amortizing loans, which encompasses most loans that carry interest, are designed so that you repay the majority of the interest in the beginning, and repay more of the principal at the tail end of the term. Here’s a mini amortization schedule for a 12 month long, $10K loan at 24% interest:
|Payment period:||Interest:||Principal:||Total cost of borrowing:|
Because you’re essentially paying the borrowing fees (interest) up-front, the earlier you can refinance, the more money you’ll be able to save. When the latter end of the term rolls around, refinancing isn’t as pertinent, given that you’ve already paid most of the fees. In the table above, you’d only be able to save a little over $50 if you refinanced after 10 months, for example.
Given the structure of loans that charge a one time flat fee instead of interest (like so), this is a moot point. If you’ve got one of those, ask this next question instead:
What fees are associated with refinancing?
Unfortunately, interest is not the only fee charged for a loan. Lenders charge extra fees that drive up the cost of borrowing and cut into your potential savings. Fees from both your new loan and old loan could come into play.
Along with interest or a flat fee, a new loan often carries charges to cover the costs of evaluating and administering the loan. These fees are normally deducted from the principal before you get the money, and can further cut into your savings.
You might incur extra charges on the other end as well, if your old lender charges a prepayment penalty. This is a fee that’s charged for repaying your loan early. For loans that charge interest, this is a fee charged based on how much you’re trying to repay, or how early you’re trying to pay it.
For some loans, especially those with flat fees, the prepayment penalty is baked in. The cost of borrowing on a flat fee loan doesn’t change, regardless of how long it might take you to repay. In other words, merchants that repay early are still responsible for paying the same amount. Some lenders, however, do forgive a portion of the remaining fee if you repay early.
Should you refinance a loan with a flat fee, you’re essentially paying interest on interest. You’re borrowing money, with an interest charge, to pay for money that you never even got to use. Bum deal.
Is refinancing worth it from a monetary standpoint? You’ll have to do the math to find out. If the cost of refinancing is greater than the cost of waiting out your old loan, then refinancing might not be worth it.
Then again, the costs might not matter depending upon how you answer the next question:
Will refinancing put my business in a better financial situation?
Saving money is not always congruent with keeping your business running. If you’re struggling to meet your daily, weekly, or monthly payments, you need to reconsider refinancing regardless of how much money you might lose.
Here’s the catch, though: make sure that the new loan is better. It’s normally not a good idea to pay off short term debt with more short term debt. This doesn’t work well for a few reasons: as discussed in the previous section, you’re losing a chunk of money by paying interest on interest. On top of that, the terms often aren’t different enough to break the debt cycle, and the business continues to struggle.
It’s a better idea to refinance a short term loan with a loan that has longer repayments and smaller monthly payments, if possible. If something needs to change, it needs to change. Refinance your debt with something that’s easier for your business to handle.
The Best Online Lenders for Refinancing
Convinced you need to get a new loan? While you can use any loan to refinance, here is an assortment of lenders to get you started.
Lenders are arranged from the easiest to the most difficult to qualify for; in general, the harder the qualification, the better their rates and fees.
These are the minimum qualifications to get a loan from Accion:
|Time in business:||N/A|
Accion (see our review) is a nonprofit lender that loans to small businesses. Their interest rates range from 8% – 22%, and, while they do have qualifications regarding which businesses can borrow, your business does not need to be of a certain age or make a certain amount of money.
These are the minimum qualifications for a loan from Able:
|Time in business:||6 months|
Able (see our review) offers mid-length term loans with APRs between 9% – 25%. They’re very easy for businesses to qualify for, but there’s a catch: you have to raise about 25% of your capital through your friends, family, and anybody else who believes in your business. Able supplies the other 75%.
These are the minimum qualifications for a Dealstruck loan:
|Time in business:||12 months|
Dealstruck (see our review) has a number of loan options available to eligible merchants, especially those with cash flow problems. The lender offers mid-length term loans with APRs between 10% – 28%, inventory lines of credit, and invoice-based lines of credit.
The minimum qualifications for a Fundation loan are:
|Time in business:||2 years|
Fundation (see our review) offers mid-length term loans to businesses that meet the above requirements, and have at least three full-time employees. With competitive rates and fees (APRs range from 8% – 30%), transparent advertising, and fantastic customer service, it’s hard to find a lender that’s better than Fundation.
These are the minimum qualifications to get a SmartBiz loan:
|Time in business:||2 years|
|Credit score:||At least good|
|Revenue:||Solid cash flow|
SmartBiz (see our review) is an online lender that partners with banks to originate general 7(a) SBA loans. Normally, SBA loans take a few months to go through the application process, a brick of paperwork, and a lot of uncertainty. SmartBiz, on the other hand, can tell you within a few minutes if you qualify, and help you through the process of collecting the necessary documentation. The best part? APRs range from about 7% – 9%.
Every business should periodically consider refinancing. The bigger and older your business gets, the more trustworthy it becomes. The more trustworthy, the better rates and fees you’ll be able to get, which puts your business in a better financial situation.
Once again, refinancing is a great way to rid yourself of difficult-to-manage short term debt, but be very careful of refinancing a short term loan with another short term loan. If the terms aren’t different enough, refinancing does nothing to solve your problems.
Need help finding the perfect lender for your situation? Shoot us an email, we’re happy to help you out!