How does refinancing a business loan work, and should I do it?

A business loan’s terms - length and monthly payments and interest rate - are all set when you borrow. Refinancing replaces that loan with a new one. And when you’re approved, there’s a “closing” when your old debt is paid off and a new debt (the refinanced loan) begins. You’ll get a new loan agreement, which takes over from the old. You can do this with many kinds of debts, including mortgages and business loans.

Ideally, you want a smart new loan to be an investment in your business. When you refinance, you want to know the process before going too far, and what’s expected from you as a borrower.

Reason to Refinance

What sparks refinancing? A lower interest rate is a big reason. During the pandemic, Freddie Mac says, mortgage rates set all-time lows. According to Bankrate, personal loan rates during this period hit their own all-time lows. There’s also the possibility that when you secured your last loan, your business and finances weren’t as good as they are today. Your credit score may have gone up, or your revenue has grown, for example. Your borrower profile may have more clout now than it did.

Cost savings aren’t always the only reason to refinance your business loan. If your loan has a variable rate, meaning the rate can go up or down, you can lock in a fixed rate with a refinance. Doing so can make budgeting and planning easier, as you won’t be blindsided if monthly payments rise. A fixed rate stays unchanged. That’s unlike a variable rate that is set to shift according to the market.

Another reason for a refinance is when you need to lower your payments. Your business may be going through a slow time. You can extend the loan’s term (its length) and lower its monthly payments. A lower interest rate can also lower your monthly payments. By refinancing, and getting a lower payment, you free up cash flow to prepare for whatever challenges are coming.

Chances are the loan you’re repaying won’t be the only one. Refinancing can mean using a new loan to pay off multiple debts. This is called a consolidation refinance. Consolidating can lower your interest rates if you were paying more before with multiple loans. It may also lower the monthly payment and take stress off if your cash flow goes down or is changing in other ways.

Any Debt Can Be Refinanced

Mortgage refinances are very common. In a Bankrate survey, 17 percent of homeowners had refinanced in 2020.

Business loans can also be refinanced. Working capital loans, equipment loans, term loans and commercial property loans can be refinanced. SBA loans are a different story. It isn’t easy to refinance them. You can refinance one through the SBA only when you need more funding and your current SBA lender has declined to lend more or change the loan. Otherwise, you’ll need a lender outside the SBA.

People also refinance personal loans, student loans, auto loans, and more. Federal student loans, however, have limitations on refinancing. You can refinance a federal loan only through a bank, credit union or other private lender. If you refinance a federal student loan into a private one, you’ll lose some benefits, including potential debt cancellation.

Applying for a New Loan

Refinancing means applying for a new loan. The lender checks your credit, your business finances and your credit history, just as in your first loan. But lenders have different requirements. Knowing this gives you a starting point. Before you apply, look at your current debt. Next, study the terms and interest rates of your current loan, and the lender’s fees for refinancing. Then compare that loan to other lenders’ offers and the costs of their refinances.

If you are refinancing a loan to save money, then lender fees might wipe out your savings. You need enough savings to make refinancing worth it. Depending on the loan, fees will vary. A refinance calculator can help you estimate the savings. LendingTree lists several fees you may be charged:

• Origination fee: This can range between 1 and 5 percent of the loan’s amount.
• Underwriting fee: This can be 1 percent of the loan’s amount.
• SBA guarantee fee: This can be 2 to 3.5 percent of the guaranteed portion.
• Prepayment penalty: If you’re paying off your existing loan early, a penalty fee may be required. It can be 2 percent or more.
• Appraisal fee: May be required when you refinance an asset, such as property.

When you apply, both your business and personal credit histories count. Know your scores and debts, your credit utilization rate, and what paperwork to provide. The age of your business and your time-in-business matter, as does your income and repayment histories. The lender will ask for documents that prove everything on your application is correct. These usually include:

• Business and personal tax returns
• Accounts payable records
• Bank statements: These show the money the business has now.
• Balance sheets
• A profit-and-loss statement
• A business plan

Depending on the loan, you can get refinanced by your current lender (if the lending guidelines allow), or from a new source. Either way, shop around and get quotes, to compare the best loan terms, rates and lowest costs you can get. Some lenders will give a soft inquiry, meaning there’s no hit to your credit score, and tell you whether you can be approved for a refinance and what it might look like. Hard inquiries can impact your credit score.

Research from Square Capital found 9 percent of its loan recipients put their advance toward refinancing or paying down other debts. Still, refinancing isn’t always the right move. A new loan can come with higher costs than what you’re paying now. But if you have an improvement or plan for your business, a refinanced loan might be able to set the stage for growth. Whether refinancing is right depends on what you find on your search, how much it costs and what the benefits are. To refinance or not is a decision you’ll need to make yourself.