How to Refinance Your Small Business Loans in 2022

In this article:

• What is small business refinancing?
• Types of loans to refinance
• How to know when it’s time to refinance a small business loan
• How to qualify for refinancing

What is small business refinancing?

Taking out a small business loan can be a smart move for entrepreneurs and small business owners that need capital. Loans may be the solution to getting startup costs, purchasing real estate or equipment, funding a marketing campaign, supplementing seasonal cash flows, or any other capital requirements.

While business loans are a great tool, knowing when, where, and how to refinance them is essential if you want to keep costs low and make the most of your money.  

Small business loan refinancing

Let’s start with the basics: What is refinancing? Simply put, it’s when you take out a new loan to pay off an old loan. The goal of refinancing a small business loan is often to secure a new loan that has lower rates and better terms than the original loan. When the refinance is complete, you won’t be taking home a lump sum of cash for the amount of the loan (you already got that with the first loan), instead, you’ll continue making monthly payments on the new loan, but those monthly payments should be lower.

Note: It surprises some people to learn that their new loan is slightly larger than the balance on their old loan, but this is normal if you roll the financing costs into the new loan. At the end of the day, you should only refinance if the lower interest rates and terms are more beneficial to your company.

Benefits of refinancing

The purpose of refinancing a loan is to have a more favorable loan agreement. There are many reasons to refinance a loan including accessing equity, securing a lower interest rate, or lowering monthly payments by extending the length of the loan terms.

Equity

One benefit of refinancing certain types of loans is the eligibility to withdraw equity. When a loan is secured by an asset, like with a commercial real estate (CRE) loan, equipment loan, or home mortgage, equity is accumulated over time when the borrower makes payments. Most borrowers become eligible to withdraw equity through refinancing when the value of their asset exceeds the remaining balance of the loan. The equity can be used for any reason the borrower sees fit.

Lower rates

Securing a better rate is another benefit of refinancing small business loans. Refinancing current debts can help business owners reduce their current interest rates. Interest rates are determined by a number of factors including the market, the borrower’s creditworthiness, the lender, and participating financial institutions. Lowering the interest rate of a loan can lower monthly payments and reduce the overall amount of money owed to the lender.

Longer repayment term

Even if your business does not qualify for lower interest rates, refinancing a loan may give you more time to pay the loan off. Extending the term of the loan will reduce the number of monthly payments, which can free up cash flow. The increased amount of available working capital can be used to fund business growth strategies, like advertising or purchasing inventory in bulk.

Refinancing vs. debt consolidation

If you’ve been researching business financing options you’ve probably seen refinancing and debt consolidation used interchangeably, even though there are some technical differences in their meanings. The term refinancing, when used correctly, refers to the replacement of an existing loan with a new loan and different terms. Debt consolidation describes the act of combining several loans into one new loan.

Most loans can be refinanced. If your small business is currently making payments on any of the following types of business loans, you may be eligible to refinance one or more debts to secure lower interest rates or better repayment terms.

SBA Loans – SBA loan programs are partially guaranteed by the U.S. Small Business Administration, so they offer lower interest rates for borrowers. Common types of SBA loans include SBA 7(a) and microloans.

Working capital loans – Working capital loans may include a variety of financing types and can often be refinanced for better terms.

Business lines of credit – A business line of credit is a type of revolving credit that borrowers can draw on whenever they need funds.

Equipment loans – Equipment financing gives small business owners the necessary capital to purchase new equipment or repair current equipment.

Term loans – Long-term or short-term loans are a common type of financing where the borrower receives a lump sum upfront and repays the loan with regular payments.

Small businesses that are making payments on any type of debt including merchant cash advances, commercial real estate loans, invoice factoring, and more may also be eligible to refinance. Check with your lender to see if your loan qualifies for refinancing.

Knowing when it’s the right time to refinance a loan will increase the benefits of the new loan. If a small business owner tries to refinance a loan too early, they may miss out on increased approval odds. When a small business loan is refinanced too late, the borrower will have already overpaid in interest and fees. To know when it’s the best time to consider refinancing options, look for the following signs.

Increased creditworthiness

During the loan application process, the creditworthiness of the borrower is evaluated by the lender during the underwriting. Eligibility requirements for small business loans vary depending on the type of loan you’ve applied for and the type of lender you’ve chosen. Over time, creditworthiness changes.  There are many factors that may change the approval odds of a small business, but the length of time in business, credit score, and income are three of the most common changes.

Time in business

Business loans are great for startup businesses or new entrepreneurs because they provide the capital necessary to turn a great idea into an operating business. When new business owners are considering funding options, they may not realize that the lack of business history works against them. Many lenders and types of business financing are only available to established businesses that have been operating for at least two years. Once your business passes the two-year mark, it may be time to explore refinancing options for those early business loans.

Improved credit score

Another factor used by lenders to determine the eligibility of a borrower is credit scores. There are two credit scores used to qualify a borrower for loans: the business credit score and the personal credit score of the small business owner.

Business credit score

When available, lenders will consider the business credit score in place of or in addition to the personal credit score. The business credit score ranges from 0 to 100 and is determined primarily by the business credit history. Business credit scores may vary significantly depending on which credit bureau the report comes from because there is no industry standard to dictate how they are calculated. Business credit information can be reviewed, for a fee, by contacting one of the three major business credit bureaus: Dun & Bradstreet, Experian, and Equifax. If your business credit score has increased, refinancing a loan may result in more favorable terms.

Personal credit score

Since business credit scores fluctuate so frequently and startup businesses may not have established credit history, lenders will also consider the personal credit score when evaluating creditworthiness. Personal credit scores are reported by multiple credit bureaus, which all use the same basic algorithm created by FICO. Credit scores may improve when payments are made on time, available credit increases, or derogatory inquiries expire. The minimum credit score required by lenders depends on the type of refinancing loan you’re applying for. To check your score, you can access one free credit report each year from Equifax, Experian, or TransUnion.

Change in business income

Another factor used to determine eligibility for a small business owner seeking a loan is the income of the business. Increased annual revenues or decreased expenses may increase net income which can have a positive impact on ratios used by lenders like the debt-to-income ratio or the EBITDA, earnings before interest, tax, depreciation, and amortization. If the net income of your small business has increased since taking out your current loan, you may qualify for a new loan with better terms.

If you’ve determined that you may benefit from new loan terms, you may be wondering how to qualify for refinancing. Lower interest rates and more attractive loan terms can be a matter of taking a few simple steps.

Decide what to refinance

Whether you are looking to refinance one loan or consolidate multiple sources of debt, you should take note of exactly which debts you will benefit most from refinancing. Taking a close look at your current loans will enable you to:

1. Know the amount you need to finance – Check the balance of your current loans to determine if you are looking to refinance one or more debts and the maximum loan amount you will need. To get this information, check recent loan statements or contact your lender.
2. Be clear about where there’s room for improvement – It doesn’t make any sense to go through the process of a refinancing application if it is unlikely your terms will improve. Look at your current debt schedules or monthly statements and take note of the interest rate, annual percentage rate (APR), and how many payments are remaining on the loan.
3. Understand any prepayment penalties– Some loans have prepayment penalties written into the terms. A prepayment penalty means that if you pay the loan off ahead of the schedule you agreed to when closing the loan there will be fees.
4. Check if the loan is unsecured – Some loans are secured by a personal guarantee or an asset, like real estate, or personal assets, like vehicles. You’ll want to understand all of the terms of your current loan to make the right refinancing decision.

Choose a lender

Refinancing may mean working with your current lender on new terms or choosing a new lender. There are two types of lenders including traditional banks, credit unions, and alternative, or online, lenders. Determining which lender is best depends on a small business’s circumstances.

Traditional lenders are great for borrowers that want to work with a well-recognized name. You may already have business checking accounts or business credit cards with a national bank and may wish to refinance your loans with the same bank. The loan application and loan approval process often take longer with a bank or credit union than when working with an online lender, so be sure your refinancing needs are not time-sensitive.

Online lenders, like Biz2Credit, are another option for small business owners looking to refinance. Online business lenders are a smart choice for borrowers that:

• Prefer multiple refinancing options
• Want an online application process
• Need a fast approval decision
• Want fast funding
• Are new business owners
• Have average or bad credit

Complete a refinancing application

Completing the loan application is easier when you’ve taken a few simple steps to prepare for the process. Having some standard financial documents on hand before beginning a refinancing application will speed up the process of paying off current business debt and taking advantage of new terms. Some documents to gather before completing an application include:

• Bank statements
• Business plan
• Business financial statements
• Income tax returns
• Current debt schedules

Review loan options

Once the lender has received your application, you should receive a financing decision quickly. There may be more than one funding option available to refinance your current debt. Schedule some time to work with your lender or comb through the terms of the new options yourself.  You’ll want to pay special attention to the monthly payments and any required down payment to make sure the business can sustain the change in cash flows. You’ll also want to check the interest rates to make sure they are lower and look for any other relevant details like origination fees and prepayment penalties. Once you’ve reviewed your options, you can sign the documents and move forward with funding the refinance.

Refinancing a small business loan can result in lower interest rates, more favorable repayment terms, or a more positive impact on your business credit history. If you’re considering qualifying for refinancing, review your current debt, apply for refinancing options, and choose a better loan for your business.

Even if you’ve been turned down for refinancing in the past, Biz2Credit may be able to connect you with the perfect refinancing options. Tim Orson, the owner of The Shear Shack Salon, had trouble finding a lender to refinance his original business loan, which held his home as collateral. Biz2Credit was able to connect Mr. Orson with a bank that agreed to refinance the loan and removed the lien on his home in less time than it took his last loan to close.