Many times it happens that you have to pay off the loan, but you cannot pay due to some issues like lack of cash or you have longer credit terms which result in huge account receivables or you cannot pay the loan. Whatever the reason may be, but you can face this situation. So what you can do to pay off the existing loan especially if that loan is maturing soon? Apply for refinance a business loan.
You heard it correctly. You can raise another debt to pay off the existing one, and it is very simple. What you have to do is:
- You have an existing loan that you cannot pay right now.
- You look for a lender, which we call to shop around lenders, who can offer better payment terms than the previous one.
- Apply for the loan.
- If approved, pay off the previous loan completely.
- Start paying for a new loan that will mature later.
Simple right? But wait. Do not make up your mind so quickly—just hand in there. Before you start shopping for the new lender, understand what is refinancing and the pros and cons of it so that you can make an informed decision about refinancing.
Refinancing is a process where a borrower (person who borrows the money) pays off his existing debt completely by taking money from a new lender (a person who gives the money). So if you see it holistically, you are just changing lenders while you are still in debt.
Refinancing is a tool that many businesses use when they are stuck with their financial condition, but they have to pay back the loan so that they can keep running their business. But what are the pros and cons of refinancing a business loan? Let us discuss them in detail:
PROS OF REFINANCING A BUSINESS LOAN
Imagine that you have to make payment of your loan but cannot do it. You need a way out so you decided to borrow some money from someone who can lend you a complete amount which is equal to that of your existing loan. Would it be great? Yup, it will be because of the following reasons:
- Can lower your interest rates:
You might have taken the loan when the economy was under crisis. This means that the lender would have charged you a higher interest rate; hence because of that, you are now facing a problem in paying back the loan. So as the economy gets stable and interest rates are down, but your loan is a fixed interest one, you are paying high interest, you can borrow another loan to pay off the existing one so that you can now pay back the loan on lower interest rates.
- Alter debt terms:
When you borrowed the loan, you prolonged it because you thought your business might not be able to sustain. Hence you thought instead of paying off the loan in the next five years let us pay it back in 10 years and by the time the loan gets mature, you would be earning some good amount of money. But the opposite happened. Your business kicked, and now you want to get rid of the loan hence you borrowed the exact amount which you have to pay for a shorter period so that you can get rid of the debt as soon as possible.
- Add up different debts:
This might not be a huge advantage but somewhat an advantage. If you have multiple loans, it is hard to keep track of payments of everyone. Hence you borrowed the total amount of all the debt and paid them off. Now you have to keep track of one payment.
- Can lower your monthly payments:
If you got a loan on a low-interest rate and you changed your loan duration, this will impact your monthly payments. The impact will most probably be positive, and you will have lower monthly payments. This will result in a healthy monthly cash flow.
CONS OF REFINANCING A BUSINESS LOAN
Wait! Just do not decide to go for refinancing right now. You must see the other side of the coin too. Refinancing is not the best option all the time. It has some cons, as well. So keep these cons into your consideration when you are looking for refinancing your business loan:
The transaction cost of refinancing:
Whenever a person transfers money, he has to pay transaction fees to the government. This means that you have to bear that amount for the lender. Although this may vary from lender to lender and loan type and size, this could be an additional cost on you, so add this cost, if it occurs, in your debt amount.
You can fall into higher interest rates. Imagine that you have to pay off a loan; otherwise, you may lose everything which you have. Hence you applied for refinancing. Now, since you are on the verge of going bankrupt, one could safeguard his money by giving you that on a higher interest rate to compensate for the higher risk. This will result in immediate pay off of the previous loan, but you have not a higher debt due to the higher interest rate.
High monthly payments:
Your previous debt was a short term debt which came into your throat. Hence you decided to go for long term debt, so you applied for refinancing a business loan. But since you are a risky borrower, your lender charges you high interest and as we all know that in long term loans you end up paying much more as compared to a short term loan. This might result in higher monthly payments.
When you change your lender, you can change your lending terms and conditions. This shift can result in losing some perks which you were enjoying with the old lender. For example, you went for a fixed interest rate of 9% when the economy was offering 14%. So at that moment, the loan was attractive. Now the market is at 4% so you could go for the shift but with the variable interest rate. Now if the interest rate jumps again to 10%, you have to pay 10% interest on your borrowed money. Hence you will always be on your toes looking at the interest rates.
After studying the pros and cons of refinancing a business loan, it is all up to you what is good for you. Refinancing might look an amazing idea, but it comes with a lot of risks as well. You might have a new loan on lower interest, but it can also backfire, and you might have to pay high interest. Similarly, you can have prolonged payment terms but on higher monthly payments and end up paying a lot. So do analyze the current situation of your business and the future predictions for the economy before making a decision.