While interest rates remain historically low, small businesses are tempted to refinance their debt. Refinancing allows business owners to ease their debt burdens, reduce interest payments and buy a longer lease on the life of their business.
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But the promise of lower interest rates should not be the sole motivation behind refinancing. If business owners find themselves paying more on interest than on principal, if their revenue is not steady for part of the year, or even if they want to improve their credit score, then refinancing may be useful.
These factors may make refinancing attractive, but other considerations remain. For starters, secured loans, such as SBA (U.S. Small Business Administration) loans and those from traditional banks, might charge a lower interest rate, but the paperwork could be substantial. For example, the SBA loan package alone requires three years of personal and business tax records.
Borrowers must also be aware of the lenders’ underwriting requirements. After the 2008 financial crisis, lending standards became tighter. Once available credit for borrowers started to dry up, regulators wanted to ease those standards, beginning in 2013. A report by the Office of the Comptroller of the Currencysaw that while 79 percent of lenders left borrowing standards unchanged in 2013, 21 percent did ease their standards.
Typically, borrowers who enjoy existing relationships with their lenders will tend to see lower borrowing costs and reduced fees along with higher credit lines. Lenders and corporate advisers alike stress that business loans should not come with usurious terms and outlandish fees. For example, interest rates on loans from Lending Club—one of the largest marketplace lenders in the United States—range from 14 percent to 19 percent APR, which are cheaper compared to other alternative lending options.
Sometimes small business owners are so often fixated on getting funding that they forget the original purpose of the loan. Before they undertake any refinancing, they should thoroughly review their company’s finances and make sure their business plans are in order. Not only will they refine their goals, but they may also uncover factors that could reduce their interest rates, or even decrease the amount of the capital needed.
A business without its future mapped out is a business with no future. An effective business plan reflects reality and anticipates the future. Since a business plan acts as a quasi-road map for the direction of the company, investors will also ask for it. If the business plan adequately details the company’s justification for refinancing its debt, good or bad, investors will be much more receptive than a company that is not transparent about its reasons.
So it’s important for small businesses to do their due diligence before they decide to embark on the road to refinancing their debt load. But with the right advice and guidance, they can get where they want to go.