For many business owners, taking on debt is just part of the growth journey. Whether you’re buying or leasing equipment, funding an expansion, or dealing with cash flow challenges, managing your debt wisely can make all the difference between thriving and struggling financially. One way to handle debt is through refinancing, which can help you get better terms, lower interest rates, or combine multiple debts into a single monthly payment. But how do you know when it’s the right time to refinance?
Let’s break down what refinancing is, the potential ups and downs, and what to consider before making that move.
What is Debt Refinancing?
Debt refinancing means replacing an existing loan or loans with a new one, usually with better terms. The new loan pays off the old debt, and you continue repaying the new loan. The main aim is to secure better financial terms, like a lower interest rate, a longer repayment period, or more manageable monthly payments.
Factors to Consider Before Refinancing
According to Fed Small Business, nearly 40% of businesses seeking financing from banks and online lenders do so to refinance existing debt. Before you decide to refinance, think about these key factors:
Current Interest Rates:
Refinancing makes sense if the new loan has a lower interest rate than your current one. Keep an eye on market rates and compare them to what you’re paying now. If rates have dropped since you took out your original loan, refinancing could be a smart move. You might also consider switching from a variable to a fixed-rate loan.
Loan Terms:
Make sure the new loan terms align with your business goals. Decide whether you want to shorten the repayment period to pay off debt faster or extend it to lower monthly payments and improve cash flow.
Creditworthiness:
Your credit scores—both business and personal—play a big role in refinancing. Lenders are more likely to offer favorable terms if you have good credit and solid financials. If your credit has improved since you took out your existing loan, this could be a great opportunity to take advantage of that progress.
Debt Amount:
Consider how much debt you currently have. If your balance is small and you’re close to paying it off, the benefits of refinancing might not outweigh the time and costs involved. The potential savings are usually greater with larger loan balances.
When to Consider Refinancing
Here are a few scenarios when refinancing could be beneficial:
- You Can Get a Lower Interest Rate:
Many business owners refinance primarily to secure a lower interest rate. If you originally took out your loan during a high-interest period, refinancing when rates drop can lower your overall borrowing costs, freeing up cash for other business needs. - You’ve Improved Your Credit Score:
If your credit score has improved since you took out your original loan, you may qualify for better terms now. Lenders are often more willing to offer lower rates or longer repayment terms to businesses with solid credit. - You Want to Consolidate Debt:
If you have multiple loans, refinancing can simplify your debt management by combining them into one loan. This reduces the hassle of managing different schedules, interest rates, and payment terms, and lowers the chance of missing a payment. - You Need Help with Cash Flow:
Refinancing can also improve your cash flow by lowering your monthly payments. You can achieve this through a lower interest rate or by extending the repayment period. Just be mindful that extending the period could mean paying more interest over time.
When Not to Refinance
While refinancing has its perks, there are times when it might not be the best option:
- Avoiding Prepayment Penalties:
Some loans come with prepayment penalties, which are fees for paying off a loan early. These penalties can be significant, potentially negating any savings from refinancing. Review your current loan agreements to see if this applies to you. - Higher Overall Costs:
Extending your loan’s repayment period can lower monthly payments but may increase the total interest paid over the loan’s life. Make sure to calculate the long-term costs before refinancing. - Excessive Fees and Closing Costs:
Refinancing often involves closing costs and loan origination fees, which can add up quickly. Before you make a decision, evaluate whether these costs outweigh the potential savings of the new loan.
