Business Loan Refinance: 7 Checks Before Replacing an Existing Loan

Before refinancing a business loan, carefully analyze the ongoing loan and the new loan from every angle. Refinancing should be done only if the analysis shows that the new loan is better than the old loan. But remember, the sound of a better interest rate may get neutralised with fees, charges, and increased monthly burden when you refinance a business loan. To see whether the math of refinancing works in your favor, look at these seven things: the exact payoff amount for the loan, the prepayment penalty, how far into the term you are, whether the savings beat the fees, your credit and revenue now versus at origination, and the new offer’s APR and terms. Finally, confirm that you will get a lien release after closing.

Refinancing a loan can be tricky. Just remember to take the time to run through all of these so you don’t end up in a tighter spot than when you began.

The Refinancing Math

The very first number you need is the exact payoff amount for the loan you’re refinancing. When you take out a new loan to pay off an existing loan, you have to satisfy both the principal and interest due on the existing loan. For an MCA, you need the exact payoff quote, not a simple balance. Your balance does not equal your payoff. Ask your current lender for an exact payoff quote that’s good for 30 days, and don’t start shopping until you have that number.

Check the terms of the current loan to see what it will cost to leave. Some lenders charge prepayment penalties. If your existing loan has a prepayment penalty (which is disclosed in the loan agreement), it’s critical to include that figure in the cost comparison calculation. These penalties often range from 1 percent to 5 percent of the remaining balance or a set number of months of interest. SBA loans charge a fee if the maturity is 15 years or more and if you prepay over 25 percent of the balance during the first three years. This fee is 5 percent in the first year, 3 percent in the second, and 1 percent in the third. Some MCA agreements include early repayment fees that range from 10 to 20 percent. If that penalty is equal to or higher than your interest savings, the refinancing math does not work in your favor.

Most loans are front-loaded with interest. So if you’re within the last 20 to 30 percent of the term, most of the interest has already been paid. Refinancing starts the amortization schedule all over again, and you might end up paying more interest. Proceed with caution, and run your numbers carefully.

Add up all the fees associated with the new loan. These may include closing costs and fees, if they apply. Add in any fees charged by your old loan. Be sure you know what the grand total cost will be for you to switch loans. Then ask yourself if the savings you’ll receive are worth the fees and other charges you’re paying. If not, the time is not right for refinancing. A typical commercial loan will have origination fees that run from 1 percent to 3 percent of the loan amount. So on a $200,000 loan, the fees could total from $2,000 to $6,000. SBA and commercial real estate loans often have closing costs of 1 percent to 3 percent as well. Also, commercial real estate loans often include appraisal fees ranging from $1,500 to $5,000.

Divide the total costs of the refinance by the monthly savings you’ll see, and that tells you how many months it will take you to break even. A timeframe of about 12 to 24 months to break even can be a good benchmark for many. A savings of one-half to one percent in interest rate may not be enough to justify a refinance. On the tax side, you can deduct costs of getting a loan over the life of the loan, not all at once. This rule applies to federal taxes on loans issued on or after December 31, 2003.

Review Your Credit Report

To refinance, you’ll have to show your qualifications now, not just when you started the first loan. If revenue and credit have taken a hit, you might not be eligible for refinancing with a lower interest rate. Review your credit report and current business financials. Applying from a weak position can mean you may not even get an offer of refinancing. If you do, the terms might not be better, or they may even be worse. Don’t shop when you know you won’t qualify. Instead, work on your finances first. One option is the SBA 7(a) loan program, which allows refinancing of debts of up to $5 million if you are unable to get credit elsewhere on reasonable terms and you can repay the loan.

If you’re refinancing an MCA, keep in mind it can cost you an effective interest rate of 40 to over 200 percent. And if the daily remittances are draining your account, qualifying can become difficult. So move while your bank account is in decent shape.

Apples-to-apples Comparison

Not all offers are created equally. Even if one loan’s interest rate appears lower, it may be more expensive than another because of the associated fees. Consider the APR on each loan you are comparing. Any lender’s first offer is rarely the best offer you can get. So compare at least two or three. Do an apples-to-apples comparison of the total cost of the loans for the full term. Also, don’t forget to check the new loan’s prepayment penalty. You can also lengthen the term to reduce your monthly payment, even at the same interest rate. For example, with a $100,000 loan at 12 percent interest, the monthly payment is about $3,320 for three years and about $2,220 for five years, freeing up an extra $1,100 every month.

If your business is in New York and you’re looking for financing of $2.5 million or less, you can take advantage of the State’s Offer Summary rules. These rules require non-bank financial service providers to present an Offer Summary. The Offer Summary must include the APR, and whether there is an extra charge for prepaying the loan.

Finally, check that your new lender will pay off the old lender. The current lender should remove the lien from the collateral when you refinance, but don’t assume that will happen. Request proof, in writing, that the lien was released and that the loan is paid in full. Ask the old lender to file a termination statement. Demand it in writing. Once nothing is owed and there’s no commitment to lend more, the old lender has 20 days to file or send it.

Refinancing doesn’t make sense for everyone at all times. That’s because the new loan’s fees and interest savings may not pencil out to your favor. You may get better terms by refinancing, but be sure of it before proceeding. Understand what you’re giving up in the old loan and what you’re getting in the new one.