For many business owners, debt is an inevitable part of growth. Whether buying or leasing equipment, funding expansion or navigating cash flow challenges, managing debt strategically can be the difference between success and financial burden. Refinancing debt may help you secure better terms, reduce interest rates or consolidate multiple debts into one monthly payment. But how do you know when it’s the right time to refinance?
In this article, we explore what refinancing is, the potential benefits and drawbacks and what you need to know before making this decision.
What is debt refinancing?
Debt refinancing involves replacing an existing loan or multiple loans with a new one — typically with more favorable terms. The new loan pays off the old debt(s), and you continue repaying the new loan.
The goal of refinancing is to secure better financial terms, such as a lower interest rate, extended repayment period or more manageable monthly payments.
Factors to consider before refinancing
According to Fed Small Business, nearly 40% of businesses that apply for financing from both banks and online lenders do so to refinance existing debt. Before deciding to refinance your business loans, evaluate the following factors to ensure refinancing is right for your business.
Current interest rates
Refinancing usually only makes sense if the new loan offers a lower interest rate than your current loan. Monitor market interest rates and compare them to what you’re currently paying. Refinancing might be a good move if rates have dropped since you took out your original loan.
You might also want to refinance to switch from a variable to a fixed-rate loan.
Loan terms
The terms of the new loan should align with your business goals. Consider whether you want to shorten the repayment period to get out of debt faster or extend it to lower your monthly payments and free up cash flow. Be clear on the terms you need.
Creditworthiness
Your business and personal credit scores play a big role in refinancing business loans. Lenders are more likely to offer favorable terms to companies and business owners with good credit, strong financials and collateral.
According to the Federal Reserve Bank of Kansas City’s Small Business Lending Survey, borrower financials, credit history and collateral are the most common reasons for denying a loan.
If your credit score and financial standing have improved since you took out your existing loan, refinancing can be an opportunity to leverage that improvement.
Debt amount
The size of your outstanding debt should also factor into your decision. If your loan balance is relatively small and you’re close to paying it off in full, the savings from refinancing may not justify the time and costs involved. The potential savings is greater when you have a large loan balance.
When to consider refinancing
There are several reasons you might consider refinancing business debt.
1. You can nab a lower interest rate
For many business owners, the primary motivation for refinancing is securing a lower interest rate. Interest rates fluctuate based on economic conditions and, if you initially secured a loan during a high-interest period, you might benefit from refinancing when rates go down.
Lowering your interest rate means reduced overall borrowing costs, freeing up cash for other business expenses or growth initiatives.
2. You’ve improved your credit score
You may qualify for more favorable loan terms if you took out your original loan when you had credit troubles but have since improved your business or personal credit score.
Lenders are more willing to offer lower interest rates or longer repayment terms to businesses with solid credit, more time in business and healthy cash flow.
If your creditworthiness has improved since you took out your original loan, refinancing could help you take advantage of your improved financial standing.
3. You want to consolidate debt
Refinancing simplifies debt management for businesses with multiple loans by consolidating multiple debts into a single loan. This reduces the administrative burden of managing different loan schedules, interest rates and payment terms and reduces the likelihood of missing a payment and facing late fees and other penalties.
4. You need help managing your cash flow
Refinancing can improve cash flow by reducing your monthly payments through a lower interest rate or extending the repayment period. Extending your repayment period means smaller monthly payments, but weigh these benefits against the possibility of paying more interest over the long term.
Reducing your monthly debt service can provide critical breathing room if you face cash flow issues or temporary financial struggles — even if you’re in a hurry. According to the FDIC, three in 10 banks can approve a small, simple loan within one business day, while three in four banks approve small business loans within 10 business days.
When not to refinance
Refinancing offers several benefits, but it’s not always the best option. Here are a few times when refinancing might not be financially prudent and could cost more in the long run.
1. You want to avoid prepayment penalties
Some loans come with prepayment penalties. These are fees lenders charge borrowers who pay off a loan before the agreed-upon term. Depending on the terms of your loan agreement, these penalties can be significant, negating the savings from refinancing. Review your current loan agreements carefully to understand whether prepayment penalties apply.
2. You’ll see higher overall costs
Extending your loan repayment period can lower monthly payments but increase the total interest you’ll pay over the life of the loan. Calculate the long-term financial impact before refinancing.
3. You’ll need to pay excessive fees and closing costs
Refinancing usually involves closing costs and loan origination fees. These fees add up and reduce the financial benefits of refinancing. Before making the decision, carefully assess whether these costs outweigh the potential savings from a new loan.
39 Views
Trending Articles
