Refinancing a loan at a lower interest rate and on more favorable terms can significantly reduce your business debt. Refinancing is attractive in many situations, but there are exceptions that a small business owner should be aware of to ensure that the refinancing meets their business goals. Randall Castillo Ortega, the founder of SME lender RACO Investment in Costa Rica and Panama, explains how to refinance a commercial loan.
When evaluating your current loan, the primary consideration is the interest rate. A lower interest rate implies a lower monthly fee. Even a few percentage decimal places of difference can represent thousands of dollars of savings over the life of a business loan. Banks and credit unions often offer the lowest interest rates, both for traditional loans and for refinancing.
“If the monthly installments are lower,” explains Castillo, refinancing a high-interest loan can leave more working capital to your business. With the excess cash, you can repay other loans you have with high-interest rates. Or, you can use it for other routine business expenses that, in turn, could be used to expand your business.”
You may notice that your credit score increases after you lower your credit utilization rate. The credit utilization rate is the amount of your debt as opposed to the total of your available credit. This rate can represent up to 30% of your credit score.
In an amortization loan, the initial installments pay the interest and the subsequent installments pay the principal. If you have already paid most of the interest on an amortized loan, even if the interest rate is high, when you pay the principal, the cost of refinancing could outweigh any potential savings.
If you guarantee commercial or personal real estate, you will need to hire an appraiser to determine the commercial value of the property. A professional commercial real estate appraiser can charge several thousand dollars.
Refinancing can require a considerable amount of time and, of course, paperwork. Do you have the resources that you will have to withdraw from the normal operation of your business to get all the documentation you need? Although this is only a detail, it can be a daunting task for the owner of a one-person or new company with few staff.
Refinancing simply restructures your debt. No matter how much you get interest rates and very favorable terms, the debt does not disappear. If a lender’s offer to “erase” its debt seems good to be true, it’s because it is. Thoroughly investigating the entity that will refinance your debt is critical to avoiding usurious lenders.
If you have difficulty meeting the payments, refinancing could trap you in cyclical debt. “Many small business owners rely on cards or lines of credit,” asserts Castillo. “This can become a dangerous cycle that will jeopardize the long-term health of your business.” Short-term debt solutions for long-term business operations are not viable. Getting stuck in debt can hinder obtaining credit and, therefore, the financial sustainability or growth of your business.
You must be frank with yourself so that refinancing does not place your company in a spiral of indebtedness. If a borrower is unable to pay its debts it could end up insolvent or bankrupt. If so, you could be forced to sell your goods at a low price. The belongings you have given as collateral for getting the loan, such as your home or other personal property, could also be at risk.
Refinancing a business loan has advantages if you qualify for a lower interest rate and this reduces your total debt. However, as with many trade issues, the decision to refinance is not always simple. Carefully weighing the benefits and disadvantages will allow you to make the most favorable decision for the financial health and continued vitality of your small business.