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With the Federal Reserve’s recent hikes of its federal funds rate, borrowers with small-business loans may think that they've missed their opportunity to refinance to a lower interest rate.
That’s not necessarily the case. A lower interest rate may still be within reach, because the rate you pay on your business loan is influenced by more than the Federal Reserve. And while a better interest rate can be helpful, it’s not the only reason to consider refinancing. Here’s what to keep in mind as you weigh your options.
Benefits to refinancing a business loan
Securing a lower interest rate
Loan type, collateral, borrower qualifications and years in business can all influence the interest rate of your business loan. If you’ve been operating for a number of years, built up your credit score or now have collateral to secure a loan, for example, you may be able to qualify for a lower interest rate — one that wasn’t previously an option for you.
“If someone is looking to get a lower interest rate, usually it’s a good idea if they’ve progressed in their business,” says Luis Ramos, director of business advising at Accion Opportunity Fund, a nonprofit lender. This can be especially true if your business was just starting out when you first received funding. “Usually, when they take their first loan, their interest rate is typically a lot higher than a business that has been in [operation] for several years,” Ramos says.
How Much Do You Need?
Locking in a fixed interest rate
The Federal Reserve has indicated that additional rate increases are likely in the future. For borrowers who currently have a loan with a variable interest rate, refinancing to a fixed-rate loan could offer a stable monthly payment going forward. However, keep in mind that the interest rates on fixed-rate loans are typically higher than the initial rate on variable-rate loans and not all lenders or loan types will offer fixed-rate options.
Increases to the federal funds rate could push your variable rate higher than you anticipated. When considering whether to refinance out of a variable-rate loan, Ramos suggests thinking about how a higher interest rate and the accompanying larger monthly payment would affect your cash flow. If you can’t comfortably make larger monthly payments, then locking in a fixed rate is an option to explore.
Reducing monthly loan payments
The amount of your monthly loan payment can have a major impact on the operation of your business. Refinancing an existing loan to reduce your monthly payments can provide some breathing room if you’re concerned about cash flow.
Cash flow is vital, according to Frank LaMonaca, a mentor at SCORE, a nonprofit organization and resource partner of the Small Business Administration. “Businesses don’t fail because of a reasonable rate of interest on their loans. They fail due to a lack of liquidity when something goes wrong,” LaMonaca says. Small-business owners “should really be laser focused on cash flow. That’s what helps them survive day to day and through any hiccups,” he says.
Avoiding a balloon payment
Refinancing can be a way to avoid a large outlay of cash for borrowers whose loan includes a lump sum due at the end of their loan’s term, commonly called a balloon payment.
“If you are in that situation, always keep an eye out for an opportunity to get out of the balloon payment that makes economic sense,” LaMonaca says. “My advice is that you start refinancing that [loan] at least one year prior to its maturity.”
Considerations when refinancing a business loan
If you face a penalty for paying off your existing loan early, weigh the expense of the penalties against the benefits of a new loan to ensure you're making the best financial move. In the future, choosing a loan without prepayment penalties or other types of exit fees can give you more flexibility to repay the loan at a time that’s favorable for you.
Business loans typically include fees in addition to the interest rate. For example, SBA loans generally require guarantee fees with each loan, including a refinance. It’s common for loan fees to be added to the principal of the loan. While they may not result in a significant increase to your monthly payment or total loan amount, these fees are something to consider when weighing the pros and cons of refinancing.
Your financial situation
The underwriting process for your refinance will be the same as that of any other business loan. You can save time and potentially money if you check loan requirements on a lender’s website or speak with a representative before applying for a loan. Review your business and personal credit history, debt-to-income ratio, accounts receivable and annual revenue to help assess your eligibility for a new loan.
Small-business owners can also reach out to nonprofits such as SCORE for free counseling or talk with their local banker, accountant or business attorney to review the benefits of refinancing their existing business loan.