by Meredith Wood
Is it time to break up with your loan?
Sometimes relationships just don’t work out. You’ve got to let it go. You tried to make it work—you really did—but you and your loan simply aren’t meant to be.
Maybe it was the term length or the payment frequency. Or maybe it was the interest rate, and you knew all along you wouldn’t last forever.
Sounds like it’s time to think about debt refinancing.
What’s debt refinancing
All right, so you can’t completely split with your loan—your lender still needs to get paid for the money you borrowed, after all.
But if you refinance that debt into a second, better loan product, you can wipe the slate clean. You’d essentially get another lender to pay back your first loan, and then convert what they paid into a second loan with more agreeable terms. Your first lender receives its cash early, your second lender gets a new customer, and you can deal with a more manageable product. Win-win-win.
You get the gist generally, but here are three specific instances when you’d want to consider refinancing your funding:
1. Surprising loan terms
Maybe you didn’t understand the terms of your first loan—that’s not uncommon. These transactions get pretty complicated, and plenty of lenders don’t try to make it any easier for you. There are lots of terms, acronyms, and variables to get confused by.
Or maybe you understood the terms correctly, but didn’t plot out—or predict—the effect they’d have on your business. It’s one thing to know how often and how much you’ll have to pay your lender, but it’s another to sit down with your balance sheet and cash flow forecast in order to see exactly how you’d make those payments.
These aren’t ideal cases, of course. You want to be as prepared and informed as possible before signing the dotted line on a small business loan.
2. Bad then, better now
So you fully grasped what you were getting into when you took that short-term loan… But now that you’re in a better place, why are you still paying so often with such a high interest rate?
If your credit score has increased, your revenue went up, you’re further away from a bankruptcy, or anything else has upped your eligibility for better funding, then it might be a good time to think about refinancing that debt. Why carry that extra financial burden if you can lighten your load instead?
3. Loans on loans on loans
The last big reason you’d be smart to look into debt financing is called debt consolidation—and it’s all the rage.
Forget about one lukewarm loan—have you taken out several? Juggling lenders might seem doable at first, but sooner or later, you’ll lose track of what goes where.
Instead, why not just put all those balls together into a single big one? If you can get a lender to combine your different loans, paying off everyone at once, you’ll have an easier debt schedule to manage and a much smaller headache.
Factors to consider
Beyond those main reasons you’d think about refinancing your debt, there are a couple of factors that will influence your decision.
1. Is it doable?
Identify with any of the problems above? Then figure out whether you can move forward with debt refinancing.
Think of it this way: You got a not-so-great short-term loan because you weren’t eligible for anything with lower rates and longer terms. In order to improve your offers, you’ll need to be more eligible. Getting a refinancing loan can be a goal when you’re thinking of when and how to push your business.
2. Is there a prepayment penalty?
Some lenders impose prepayment penalties on borrowers who try to sneak out early. It would be great if you knew about any penalties when you signed up, but these clauses often get worded evasively or buried deep into contracts.
Make sure the benefits of refinancing outweigh the costs of paying early, if your lender will penalize you.
3. What are you looking for exactly?
Finally, don’t just rush into a refinancing loan because its numbers look better. Understand its APR, check that its term length, and frequency meshes with what you want, and compare its payment plan to your cash flow forecasts with a loan amortization schedule.
And remember—refinancing your first loan into a second doesn’t have to be the end. If you’re a responsible borrower who takes care of your business, you might be able to refinance your funding over time into the best loan products available.
Meredith Wood is the editor-in-chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. She is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more.