How to Refinance a Small Business Loan

By Rebecca Lake
April 29, 2019

If you have a small-business loan, you might be wondering if you can refinance it. Business loans, like most other loans, can often be refinanced — meaning you get a new and ideally better loan to replace the old one. Refinancing could save you money by lowering your interest rate or freeing up additional working capital in your budget if you can reduce your monthly payment.

Usually, refinancing a small-business loan is a pretty straightforward process, but equip yourself with knowledge before you begin.

How Business Loan Refinancing Works

The mechanics of refinancing a business loan aren’t that different from refinancing a mortgage or a student loan. The process involves getting a new loan to pay off your original loan. You then make payments on the new loan going forward. Ideally, the new loan has more favorable terms, such as:

— A lower annual percentage rate, or APR

— Lower monthly payments

— Less frequent payments

The terms a business owner may qualify for depend on several factors.

“When you refinance a business loan, the terms you get are typically based on what the original purpose of the debt was,” says Maggie Ference, SBA program director at Huntington National Bank in Columbus, Ohio. “In cases where the purpose of the debt is tied to an asset that might be past its useful lifespan,  such as a piece of equipment, the refinance terms can be more aggressive.”

Refinancing a business loan may have a few added steps, however, compared with refinancing personal or other types of loans. As with your initial business loan, your new business loan may require extensive documentation and specific qualification factors.

“When collateral is involved, the lender may require, among other things, a security interest in receivables as well as inventory and equipment,” says James Cassel, chairman and co-founder of Cassel Salpeter & Co. investment banking in Miami.

Types of Business Loans You Can Refinance

Business loans aren’t all the same, and you may be wondering whether the nature of your loan makes a difference for refinancing.

“There are actually very few types of business debt that can’t be refinanced,” Ference says.

With that in mind, the kinds of business loans you may be able to refinance include:

— Term loans

— Working capital loans

Equipment loans

— Commercial real estate loans

— Microloans

You can also refinance business lines of credit and merchant cash advances.

If you have a Small Business Administration loan, however, refinancing could be a little tricky. Refinancing is only possible when borrowers have new financing needs and their SBA lender has either denied funding or refused to modify their loan. The alternative may be seeking a non-SBA loan and using that to refinance SBA or other business debts.

Pros and Cons of Refinancing Small Business Loans

Business owners may enjoy several distinct benefits when refinancing a business loan. Ference says the biggest advantage is the potential to improve business cash flow.

“The ability for a small-business owner to consolidate his or her balance sheet is extremely important, especially for small businesses that have grown rapidly and are looking to increase their organic cash flow,” she says. “You get a cash flow benefit when the refinancing of your debt allows for a lower monthly payment.”

The cash flow struggle is real for many business owners. In a February 2019 Kabbage survey, 51 percent of business owners said they sometimes sacrificed paying themselves for months at a time to smooth the flow of cash in and out of their businesses.

Freeing up room in your business budget can be helpful if you’re hoping to pay yourself regularly or to build up a cushion of savings for your business. Additionally, the extra funds can help you keep pace with rising overhead costs or cover necessary business purchases without taking on additional debt.

Refinancing at a lower interest rate can yield savings in a different way if it reduces the total cost of borrowing and allows you to pay off the loan faster.

On the con side, a few considerations:

— Possible prepayment penalties or fees when paying off the old loan early.

— The effect of applying for a new loan on your credit score.

— The current interest rate environment.

Lenders charge a prepayment penalty when a loan is paid in full before the loan term ends. This fee, which is typically a percentage of what you borrowed, allows the lender to recoup some of the interest charges it can’t collect when you repay a loan early.

Not every business lender charges a prepayment penalty; these penalties are more commonly associated with mortgages or car loans. But read the fine print on your original loan documents to determine if one applies and how much you might pay.

Also, refinancing a business loan — or any loan, for that matter — could affect your business and/or personal credit scores if the lender does a hard pull of your credit. This results in an inquiry on your credit report. A single inquiry may have a minimal effect on your credit scores, but multiple inquiries for loans in a short time span could signal to lenders that your business is desperate for financing.

As far as rates go, business loans, including SBA loans, often have interest rates that are tied to the prime rate, which is the lowest rate at which banks lend to their most creditworthy customers. It can change depending on economic factors.

If you took out a small-business loan when rates were relatively low, refinancing after rates have increased may not be as fruitful for interest savings. Of course, you might want to refinance for other reasons, such as extending your loan term and reducing your monthly payment.

Qualifying for a Business Refinance Loan

After weighing the possible advantages and disadvantages of refinancing a business loan, the next step is knowing what you need to qualify.

“Qualifying for a refinance loan really varies by lender — both with banks and nonbanks,” Ference says. “Minimum credit scores, revenue, time in business and a host of other factors will all be taken into account, and it will all be based on the individual credit expectations of the lender.”

Some of the factors that could work against you when applying for a refinance loan include:

— A poor personal credit score

— A recent bankruptcy filing

— Outstanding tax liens

— Not enough time in business

— Not meeting minimum annual revenue requirements

Still, this doesn’t mean you won’t qualify; it just means your business and personal finances will come under closer scrutiny to get approval for a refinance loan.

“A bank that might provide an unsecured loan will look at the overall creditworthiness of the business borrower and may want a personal guarantee,” Cassel says.

A personal guarantee is a legally binding agreement that gives the lender the right to collect from you personally if you default on a business debt. In other words, the lender could use business assets to recover a defaulted loan as well as personal assets such as your home or your bank accounts.

One upside to signing a personal guarantee, Cassel says, is that it could help you secure a lower interest rate on a refinance loan.

Is Refinancing Small Business Debt the Right Move?

Whether refinancing makes sense is unique to every small-business owner.

If refinancing would save you a substantial amount of money on interest without triggering a prepayment fee from the original lender, for instance, then it may be a no-brainer. On the other hand, refinancing business debts may not be as beneficial if you’re only getting a marginally lower rate or monthly payment.

When determining whether to refinance, consider:

— What you hope to accomplish by getting a new loan.

— The cost to refinance, including underwriting, origination and other fees, which may total 1% to 5% percent of the loan.

— Your business credit and financial profile.

— The rate and loan terms you’re most likely to qualify for.

— Whether the lender requires collateral or a personal guarantee for a refinance loan.

Remember to account for differences in lending practices between banks and alternative lenders, such as online lenders. Banks, for example, may offer lower rates but require a higher credit score or more revenue to qualify than an alternative lender.

“Many times, you’re not comparing apples to apples,” Cassel says. “Be careful to understand the real all-in costs as well as the fine print.”