A Rising Fed Rate Doesn’t Have to Derail Your Business Loan Refi

With the Federal Reserve’s recent increases in its federal funds ratesmall business loan borrowers may think they missed their opportunity to refinance to a lower interest rate.

This is not necessarily the case. A lower interest rate may still be within reach because the rate you pay on your business loan is influenced by more than the Federal Reserve. And while a better interest rate can be helpful, it’s not the only reason to consider refinancing. Here’s what to keep in mind as you weigh your options.

Benefits of refinancing a business loan

Assurance of a lower interest rate

Loan type, collateral, lender qualifications and years in business can all affect the interest rate of your business loan. If you’ve been employed for a number of years, built up your credit score or now have collateral to secure a loan, for example, you may qualify for a lower interest rate – one that wasn’t an option for you before.

“If someone wants to get a lower interest rate, it’s usually a good idea if they’ve advanced in their business,” says Luis Ramos, director of business consulting at Accion Opportunity Fund, a nonprofit lender. This can be especially true if your business was just getting started when you first received funding. “Typically, when they take out their first loan, their interest rate is typically much higher than a business that’s in [operation] for several years,” says Ramos.

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Lock in a fixed interest rate

The Federal Reserve has indicated that additional rate hikes are likely in the future. For borrowers who currently have a variable rate loan, refinancing to a fixed rate loan can provide a stable monthly payment going forward. However, keep in mind that the interest rates on fixed rate loans are typically higher than the initial rate on variable rate loans and not all lenders or loan types will offer fixed rate options.

Increases to the federal funds rate can push your variable rate higher than you expected. When considering refinancing out of a variable-rate loan, Ramos suggests thinking about how a higher interest rate and the associated larger monthly payment will affect your cash flow. If you can’t comfortably make larger monthly payments, then locking in a fixed rate is an option.

Reduction of monthly loan payments

Cash flow is essential, according to Frank LaMonaca, a mentor at SCORE, a nonprofit and resource partner of the Small Business Administration. “Businesses do not fail because of a reasonable interest rate on their loans. They fail because of a lack of liquidity when something goes wrong,” says LaMonaca. Small business owners “have to be really laser-focused on cash flow. This is what helps them survive day to day and through any hiccups,” he says.

Avoid a balloon payment

Refinancing can be a way to avoid a large outlay of cash for borrowers whose loan includes a lump sum due at the end of their loan term, commonly called a balloon payment.

“If you’re in that situation, always keep an eye out for an opportunity to get out of the balloon payment that makes economic sense,” LaMonaca says. “My advice is that you start refinancing it [loan] at least one year before its expiry date.”

Considerations when refinancing a business loan

Prepayment penalties

If you face a penalty for paying off your existing loan early, weigh the cost of the penalties against the benefits of a new loan to ensure you make the best financial move. In the future, choosing a loan without prepayment penalties or other types of exit fees can give you more flexibility to repay the loan at a time that is convenient for you.

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Loan Fees

Business loans usually include fees in addition to the interest rate. For example, SBA loans usually require guarantee fees with each loan, including a refinance. It is common for loan fees to be added to the principal amount of the loan. While it may not result in a significant increase in your monthly payment or total loan amount, these fees are something to consider when weighing the pros and cons of refinancing.

Your financial situation

The underwriting process for your refinance will be the same as that of any other business loan. You can save time and possibly money if you check loan requirements on a lender’s website or speak with a representative before applying for a loan. Review your business and personal credit history, debt-to-income ratio, accounts receivable and annual income to help determine your eligibility for a new loan.

Small business owners can also reach out to nonprofit organizations like SCORE for free counseling or talk to their local banker, accountant or business attorney to review the benefits of refinancing their existing business loan.

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