Business loan refinancing is a powerful tool to lower the cost of your financing. There are different ways to use business loan refinancing which include to lower your loan payments or improve your cash flow. Regardless of why you’re refinancing your loan, there’s a lot to consider making sure it’s the right choice for you.
In this post, we will review what loan refinancing is, why it is done, and its pros and cons.
What is Loan Refinancing?
Business loan refinancing is the process of replacing one loan with a different one. Refinancing can refer to replacing alternative types of financing such as an equipment loan or merchant cash advance.
Those who improved their financial situation might qualify for loans with better terms, so they refinance to lower their total cost. Other people refinance so they can take out a larger loan to avoid gaps in financing. You can also use refinancing to lower your monthly payments.
As you can see, small business loan refinancing can help you in a variety of ways, so it’s important to consider what refinancing can do for your business.
The Pros of Loan Refinancing
Better loan terms
If you took out a loan while your business was still maturing, you may be able to access better interest rates. Refinancing your loan means getting a new loan which comes with fees you wouldn’t have otherwise paid if you didn’t refinance. Still, for some entrepreneurs, the improved terms will be well worth refinancing.
Improved cash flow
Having free cash flow give you the chance to jump on opportunities that arise. Loan refinancing can unlock cash by lowering your monthly payment.
You might find a loan with a longer term that enables you to make lower monthly payments. Make sure that you’re aware of additional expenses that you might end up paying so that you get the lower monthly payments.
Lower borrowing costs
Lowering your borrowing costs can reduce the extent to which they erode your profits. This can also improve your debt service ratio which makes it easier to qualify for additional financing if you need it. Plus, lower costs of capital make your business more attractive to investors or potential buyers.
The Cons of Loan Refinancing
It is a hassle
It might not be with the hassle because there are other costs to consider such as origination and appraisals. You could be subject to a prepayment penalty which will add to the expense of refinancing. Your savings can be minimal or nonexistent even.
Potential high long-term costs
A common reason for refinancing is to lower your monthly payment. You can do this by taking out a long-term loan. The lower your monthly payment, assuming all else is equal.
However, you might end up paying more interest over time even if your payments are low. This is because, as your payback period extends, the proportion of each payment that goes to your loan principal is smaller. The result is a larger total amount of interest expense over the life of the loan.
Negative impact on your credit score
When you refinance a loan, it’s essentially just like getting a new loan, which means that your new lender will request to review your credit report. This request will show up as a hard inquiry. Hard inquiries negatively impact your credit score for about one year.
The Bottom Line
Refinancing is not for everyone. Once you establish clear goals for your refinancing strategy, you need to figure out if it’s right for you by doing some math. However, remember that loan refinancing is a time-consuming process so a little savings over many years or slightly reduced payments might not be worth it.