Business loans allow a small or medium enterprise to expand its operations, streamline working capital, and boost manufacturing. In India, both banks and non-banking financial companies offer business loans and loan refinancing for SMEs. Loan refinancing can help a business save more money in repayments of an existing loan. However, selecting the right lending partner is crucial for a loan refinancing to be of benefit for your enterprise.
What is loan refinancing?
Loan refinancing is the process of taking out a new loan to pay off an existing loan. There are several reasons why you might consider loan refinancing, such as to get a lower interest rate, shorter term, or lower total interest. Refinancing can potentially improve your financial situation, but it is important to understand your current loan terms, including any late fees and interest rates, before making a decision. Not understanding your current loan terms can lead to poor choices and a greater financial burden.
Loan refinancing is possible for a variety of refinance loans, including student loans, personal loans, and business loans.
How does loan refinancing work?
Here’s how loan refinancing works:
- First, you check the terms of your loan, including the monthly payment, remaining balance, and interest rate.
- Next, you determine the interest rate you need to get for offsetting the prepayment penalty, which some lenders charge for paying off the loan early. This penalty may be higher than the potential benefits of refinancing.
- Finally, you search for lenders that meet all of your requirements. It is important to compare several lenders, their terms, and interest rates before choosing one.
Sometimes, market conditions may not be favourable for loan refinancing. In this case, it is better to wait and try to refinance your loan when interest rates are lower.
Deciding if loan refinancing is right for your business or not
Most businesses apply for business loan refinancing because they wish to save money by getting better interest rates for the remaining principal amount of an existing business loan. Obtaining a loan refinancing deal at lower interest rates is possible in two scenarios. Number one, the market interest rates for business loans have dropped due to government and RBI policies. Number two, your business situation has improved, meaning your income / sales are higher and your company’s credit rating has improved, since taking the business loan.
Other reasons why businesses apply for loan refinancing are, moving from a variable rate loan to a fixed rate loan or accessing equity in a commercial property with a cash-out refinance.
Loan refinancing also allows businesses to move from one financing class to another. For example, recovering a collateralized asset through an unsecured business loan, paying off construction debt with permanent financing, or replacing a long-term loan with more flexible, renewable working capital loan.
The thing to know about loan financing is that there are as many options as there are debts. Ultimately, determining whether you need business loan financing depends on your business goals.
When Should You Avoid Refinancing?
If you are wondering if loan refinancing is good or bad, you need to understand if it truly benefits your financial situation. In cases where refinancing would raise your debt costs instead of lowering them, proceeding would be counterproductive. Plus, having a low credit score can make it challenging to secure better loan terms, and applying for a new loan may further reduce your credit score. Therefore, focus on improving your creditworthiness before considering refinancing. Finally, if you only have one small loan, refinancing may not yield significant advantages and could involve unnecessary costs.
Basic requirements for refinancing a business loan
Different lenders will have different turnover, documentation and verification requirements for refinancing business loans. Where traditional lenders like banks tend to have an extensive documentation policy, instant business loan providers like Lendingkart only ask for the bare-essentials for approving loans and loan refinancing. In general, lenders require profit and loss statements, balance sheets, and tax returns for multiple periods to assess the financing risk and approve refinancing terms accordingly.
Eligibility requirements for a loan refinancing can depend on the type of your existing financing vehicle. For example, if you are looking for invoice factoring, the lender may not ask for your credit score at all because you are simply collateralising the accounts receivables. In this case, a lender maybe more interested in the credit worthiness of your commercial clients.
Advantages and Disadvantages of Refinancing
Refinancing Pros
- Locking a Lower Interest Rate: Securing a lower interest rate can significantly reduce long-term costs and lower your EMIs. This can provide you with more funds for business operations. Lower monthly payments ease financial strain and leave you with more capital to invest in the growth of your business.
- Accelerating Debt Repayment: If interest rates drop, you could refinance for a shorter loan term, potentially reducing total interest costs. This allows you to clear your debt faster and strengthens your financial standing. This is especially so if paying off your loan early aligns with your business goals.
- Enhancing Cash Flow in Challenging Times: Refinancing can be particularly helpful during a financial crunch. By opting for more favourable terms early in your loan tenure, you can maintain a steady cash flow while managing repayments comfortably. This ensures your business stays resilient during tough times.
Refinancing Cons
- Repayment Penalties: Lenders often impose prepayment penalties if you repay your loan ahead of schedule. These charges could offset the savings from refinancing. This makes it crucial to calculate all costs accurately before proceeding to ensure refinancing is financially beneficial.
- Limited Impact on Long-Term Loans: Switching to a lower interest rate may not yield substantial savings if your current loan already has a long tenure or manageable rates. Plus, factors like application fees and a possible credit score impact from a hard inquiry might outweigh the refinancing benefits, especially if the rate difference is minimal.
Helpful tips for refinancing your business loan
There are some things which should be kept in mind before applying for a business loan refinancing. These prudent measures can help you in assessing the true value and benefits of refinancing your business debt.
- Start with a clear goal that you wish to achieve by refinancing the debt. Sometimes, the right financial product for your need may be different from the one you select for recovering an asset or lowering your interest rates. This means, by selecting the wrong financial product, you may end up losing more money.
- Evaluate your existing loan, the amount and tenure left, and the interest you will be paying. Compare these things with the principal amount of your new loan, the tenor and interest payments for the refinanced loan, adding prepayment penalties and new loan processing charges to the total cost. This will give you a definitive picture of the financial vehicle’s viability.
- If you are servicing parallel business loans and are considering business loan consolidation, then do the above mentioned calculations for all loans before making a decision. The advantage of consolidating business loans is that you need to pay a single EMI instead of several fractured transactions every month. However, missing critical financial details such as tenor and interest rates alignment can lead to a significant increase in the monthly EMI amount. Read more about EMIs on EMI Calculators and Business Loans – Facts and Myths.
- Look for loan refinancing deals online. Have a closer look at the payment terms, minimum interest rates, collateral requirements, processing charges and prepayment process of the lender before applying for loan refinancing.
At the end of the day, loan refinancing is just like all other financial products and services which promise to unburden your financials. When done right, refinancing can bring huge benefits for your business. But if done wrong, it can also alter your financial wherewithal and disrupt operational readiness.
Step-by-Step Guide to Refinance a Business Loan
Step 1: Define Your Refinancing Goals
Identify clear objectives, like reducing interest rates or adjusting EMI and tenure. Factor in any processing fees and prepayment charges to make an informed decision.
Step 2: Check Eligibility
A high credit score improves your chances of refinancing on favourable terms. Ensure you have a realistic repayment plan to avoid any impact on your credit score.
Step 3: gather Required Documents
Organise essential documents, including profit-and-loss statements, tax returns, and bank statements. These provide a clear picture of your financial health to potential lenders.
Step 4: Select the Right Lender
Compare lenders based on interest rates, repayment terms, and credibility. Consider either your current lender or a new one that offers a soft credit check for prequalification.
Step 5: Submit Your Application
Once you choose a lender, prepare the required paperwork, such as ID proof, bank statements, and business registration documents. The approval process is usually quick and allows you to refinance smoothly.
Get in touch with Lendingkart
Lendingkart is a leading NBFC in India, offering small-ticket finance of up to ₹ 2 crore for SME owners and startups. We have expert advisors in our employ who can assist you in selecting the right loan refinancing vehicle for your commercial debt. Moreover, you can also avail renewable business loans at competitive interest rates for a period of up to 2 years from Lendingkart. We disburse funds within 3 days of approval and verification of your business and personal information.
To apply for a small business loan, you can either visit our Lendingkart website or download the Lendingkart mobile app for your Android. To know more about business loans and related topics, follow our blog.
FAQs:
1. Is it a good idea to refinance a loan?
Loan refinancing can be a good idea, but the market conditions and your existing loan terms must be good enough. Sometimes, the current interest rate can be very high for refinancing your loans feasibly.
2. Does refinancing hurt your credit?
Refinancing may lower your credit score as the lender will perform a hard credit inquiry. So, you must only consider refinancing if your credit score is high enough or the benefits outweigh the low score.
3. Can you save money by refinancing a loan?
A refinance loan can help you save money. For this, you must get a new loan with a shorter tenure or lower interest rate. A shorter tenure will reduce the overall interest paid, and the low interest rate will reduce the monthly instalments.
4. What is an example of refinance?
You get a loan for INR 5 L to be paid within three years. Your credit score was low during the approval, making the interest rate high. After a year, you managed to improve your credit score, get a loan for lower interest, and pay off the old loan.
5. How many times can I get my personal loan refinanced?
There is no legal limit for refinancing your loan. You only need to consider two factors: the lender’s requirements and the financial feasibility. If you can refinance to get more favourable terms, it would now be wise to not refinance.
