Refinance Business Loans: What You Need to Know
After several years of paying down a business loan, you may be able to further reduce your debt. You could refinance business loans to lower interest rates or extend repayment terms — or possibly both.
Refinancing your business loan involves applying for a new loan, either with the original lender or a different one. After repeating the loan process, you get a loan that pays off your existing debt.
There are several factors to consider before moving forward with a business loan refinance. Keep reading to understand what the process could entail and how your business could benefit.
- What does it mean to refinance business loans?
- Pros and cons of refinancing business loans
- Business loan refinance: 3 important steps
- When you should — or shouldn’t — consider refinancing
What does it mean to refinance business loans?
If you qualify for a lower-cost loan, refinancing business debt could lower your monthly payments and reduce your interest rate.
You can refinance your business debt through the following options:
- Bank loans: Traditional banks may refinance business debt as part of a larger business loan. However, banks typically have strict borrower requirements, so it could be challenging to refinance debt through your local bank.
- SBA loans: The U.S. Small Business Administration partners with lenders to guarantee loans made to small businesses. Because of the SBA guarantee, more risky borrowers could qualify for this type of financing. SBA loans have a range of purposes, including debt refinance. However, you may not be able to refinance an existing SBA loan with another SBA loan. It might be possible if you need additional money and have been rejected by your lender or if it won’t modify your current terms.
- Loans from alternative lenders: Non-bank business lenders provide funding to businesses that may not meet the requirements for traditional loans. Community Development Financial Institutions (CDFIs) — certified banks and credit unions that serve low-income communities — could also provide refinancing loans.
When refinancing through a bank, you typically could get an interest rate between 5% and 10% on a term between one and 10 years. SBA refinance rates generally range from 4.5% to 6.5% with terms between seven and 25 years. If you refinance with an alternative lender, your rates could still be considerably high — possibly 9% to 50% — with terms between four months and five years.
Although the purpose of refinancing is to save money, you will incur other costs. A refinance loan would most likely come with closing costs, which are typically 3% to 6% of your total loan amount. You should review the other expenses (and typical ranges) associated with a new loan, such as:
- Origination fee: 1% to 5% of the loan amount
- Underwriting fee: 1% of the loan amount
- SBA guarantee fee: 2% to 3.5% of the guaranteed amount
- Prepayment penalty: 0% to 2% for paying down debt before the term ends (SBA loans have a different range, but we’ll get into that later)
- Late fee: 3% to 6% for overdue payments
Be sure that the cost of refinancing doesn’t outweigh the savings of lowering your debt. If the expense of the new loan is too high, you may want to reconsider a business loan refinance. You could use LendingTree’s business loan refinance calculator to find out your potential for savings.
You could also consolidate your business debt, which involves rolling all existing debt into a new loan and making one monthly payment. This could also lower your interest and monthly payments and shorten your repayment schedule. Consolidation could be a better option than refinancing if you have multiple business loans.
Interest rates dropped, small business loan activity spiked as coronavirus hit
New, fixed-rate small business loan interest rates offered by banks hit a multiyear low in the first quarter of 2020, amid the start of the coronavirus pandemic. For those considering refinancing their business loans, now could be a good opportunity. Here are some highlights.
- The median interest rate on new, fixed-rate small business loans in the first quarter was 4.97%, down from 5.79% in the first quarter of 2019, according to data from the Federal Reserve Bank of Kansas City’s Small Business Lending Survey. This was the lowest rate since the fourth quarter of 2017, when the median interest rate was 5.06%.
- A business owner would owe about $6,600 in total interest on a $50,000 small business loan paid off over five years, assuming a 4.97% interest rate. If the business owner received a 5.79% interest rate, they’d owe $7,700 in total interest. That’s a savings of $1,100, or about 17% of what the borrower would owe in interest.
- Banks saw extreme volatility in demand for new small business loans. Only 54% of banks reported basically no change in loan demand in the first quarter of 2020, compared with 73% saying loan demand remained unchanged in the previous quarter in 2019. The first-quarter volatility goes in both directions, though, with 24% of banks reporting greater demand for loans and 22% reporting lower demand for loans.
- The total dollar amount requested in small business loan applications jumped quarter over quarter by more than 10 times. In the fourth quarter of 2019, business owners applied for $17.6 billion in small business loans, but that figure skyrocketed to $180.4 billion in the first quarter of 2020. More than 7 in 10 respondents to the survey conducted in May cited the Paycheck Protection Program (PPP) as a way to lessen their financial hardships.
Pros and cons of refinancing business loans
Before taking out a new loan, consider these benefits and downsides of refinancing.
Reduced cost of financing: If you’re able to secure a better rate and more favorable terms, refinancing your business loan could save you money in the long run.
Better cash flow: Lowering your loan payment would free up cash flow within your business. You could invest the extra funds in payroll, equipment, inventory or other aspects of the business.
Increased funding amount: If a loan refinance would make a positive impact on your cash flow, a lender could approve you for a larger loan amount based on your debt-service coverage ratio, which measures whether you have enough cash to cover your debt. Getting approved for a larger loan could save you from taking out a second loan if you need additional funding for your business.
Credit score could take a hit: A lender would need to make a hard credit inquiry before refinancing, which could have a short-term negative impact on your score. Refinancing could also negatively affect your score, as it would reduce the average age of your credit. If you already have low credit, refinancing may not be worthwhile.
Prepayment penalties could be in place: Make sure your current lender does not charge prepayment penalties before refinancing your loan. Paying off your loan early could incur a penalty that was built into your loan agreement, and that fee might diminish the savings you would have earned through refinancing. For instance, SBA 7(a) loans come with a prepayment penalty for loans with terms exceeding 15 years. You’d incur a 1% to 5% fee if you pay off your loan in the first three years.
Collateral could be required: A lender may require collateral to secure the new loan, even if you did not have to offer it on your previous financing. Personal or business assets could be used as collateral, and the lender could seize those assets if you default on the loan. If you use property as collateral, you may need to hire an appraiser to value the real estate, which would be an extra expense. The potential to lose the rights to your assets is a risk to consider before refinancing business loans.
Business loan refinance: 3 important steps
Here are a few steps to take to ensure the refinance process goes smoothly.
1. Determine how much you owe
Review your current loan balance and interest rate to understand how much you would need to borrow to pay off the total amount you owe. You would also need to make a note of your loan term. When obtaining a refinanced business loan, the new loan should have more favorable rates and terms than what you have.
2. Gather application documents and information
A lender would want to see evidence that your business could repay a new loan. Be prepared to submit information on the following:
- Credit history
- Business plan
- Balance sheet
- Cash flow history and projections
- Accounts payable
3. Research and compare lenders
You could apply for a refinance loan from the same lender or find a new financial institution. To make sure you get the best results from refinancing, be sure to compare loan terms, fees, interest rates and repayment schedules across various lenders.
You could try to pre-qualify with lenders that perform soft credit pulls, which wouldn’t impact your credit score. But for lenders that perform hard credit pulls when you apply, aim to do your rate-shopping in a 14- to 45-day window. By doing this, your applications will likely count as one inquiry on your credit report.
The type of financing you obtain could affect the aspects of your refinance loan. For instance, a secured loan would require collateral but would likely have a lower interest rate. Interest may be higher on an unsecured loan, but you wouldn’t need to offer collateral.
When you should — or shouldn’t — consider refinancing
Refinancing doesn’t make your debt disappear. It repackages your debt in a way that should work better with your budget.
If you’re struggling to make your current loan payments, refinancing likely wouldn’t solve your problem. Taking on more debt to pay off your existing balance could put you in an ongoing debt cycle that may be difficult to escape. You risk facing bankruptcy or losing your business or personal assets if you cannot repay loans.
Refinancing a business loan would be a better choice for business owners who have improved their credit score or increased revenue since initially borrowing funds. Loan approval would be based on your personal credit profile, and you may have a better shot at securing more favorable rates and terms if your credit score is now higher.
An improvement in your business finances would have a similar effect. If you’ve had three to six months of higher net profit, lower debt ratios and greater operating income, you would be more likely to be approved for better rates and terms. Higher revenue, an increase in the value of your assets and reduced use of available credit would also indicate that your business is financially healthy. It may be best to wait until you see these signs of improvement before attempting to refinance debt.
The length of time you’ve been in business could also increase your appeal as a borrower, especially if you were not in operation long when you took out your initial loan. More time in business makes you more likely to be able to pay off debt, which increases your creditworthiness.
When you should wait
But refinancing may not be the right choice for all business owners with debt. As we’ve noted, your credit score will take a hit when you refinance a loan, which could hurt your chances of applying for other types of financing in the future.
Make sure you weigh the costs of taking out a new loan with the money you’d save from refinancing. As long as the overall expense doesn’t exceed your potential savings, refinancing business loans could be a viable option for reducing your debt load.