No business owner wants to get stuck with short-term debt.
A small loan can make a big impact on your business’s growth if you use that extra capital right but all too often, business owners fall into a cycle of expensive debt and struggle to find their way out.
Almost half of all small businesses that fail each and every year cite financing as the cause. So how can you escape the risks of short-term debt?
Refinancing is one option. Let’s talk about what it is and how it can help with your short-term debt.
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Refinancing: What Is It?
Refinancing means using the proceeds of one loan to pay off the payments you owe for another loan. Here’s the idea: compared to that first loan you’ve taken out, your second loan would come with a lower interest rate, a longer term, a larger loan amount, or some combination of all three. Using Loan #2 to pay off Loan #1 could help you save money, give yourself more time to pay off your debt, and pump more capital into your business.
The caveat here is that, in order for your debt refinancing to be worthwhile, the benefits of your second loan need to outweigh the costs of refinancing. Taking out any business loan and sometimes especially a refinancing loan often comes with fees and requires your time, energy, and attention. If you’ve got short-term debt for your business, you essentially have two options when it comes to refinancing: take on another short-term loan or “graduate” into a better class of funding.
Option #1: Refinance Short-Term Debt With More Short-Term Debt
Chances are high that if you’re looking to refinance one loan with another similar loan especially if they’re both short-term debt you won’t be getting a significantly better deal. The interest rate, term, or loan amount might be a slight improvement, but it probably won’t be obvious that the benefits trump the costs.
There are some good reasons to refinance short-term debt with more short-term debt, though. First, your business might just need the extra capital. Even if it’s not a massive jump up in funds. If the financing you’d get from refinancing beats out the fees you’d pay to take on another loan, then refinancing could be the right move.
Second, lengthening your loan term (even by a little) could go a long way to easing up your cash flow. Your refinancing loan might add just a handful of months to your repayment, but that small stretch has the potential to give you more breathing room or bump you into a less frequent payment schedule.
Related Article: 5 Surprisingly Cheap Forms of Small Business Financing
The Risks of Short-Term Refinancing
However, you need to be careful not to get stuck in a cycle of short-term debt. This can be a dangerous place for a small business owner, refinancing one short-term loan with another over and over. You’ll wind up paying interest on interest, spending money for capital you didn’t get to use. It could even lead to the end of your business.
And there’s a bad reason to refinance, too: refinancing short-term debt to stay afloat. If you need more money right away and additional short-term debt is the only way to get it, then you might want to take a step back and reevaluate the state of your business. Is financing really the issue? Or are there other, more central problems preventing you from generating revenue or bringing in enough customers? Refinancing shouldn’t be a band-aid.
If you’ve fully calculated the advantages of refinancing and stacked them up against the costs of taking on another loan, then refinancing short-term debt with more short-term debt shouldn’t pose a problem.
Option #2: Graduate Into a Better Loan
It’s also possible to refinance your short-term debt into a significantly better loan: a bigger amount with lower rates and longer terms. If your business has hit a certain milestone since you took on that initial short-term loan, you might qualify for a different class of financing altogether. That might mean reaching two years in business (which only two-thirds of small businesses do), hitting a 700 in personal credit (the average is 695), or bringing in more than $100,000 in annual revenue. Each of these could potentially make you eligible for a more traditional term loan or even an SBA loan.
Be on the lookout for these opportunities, because this is where refinancing can make a serious, long-lasting impact on your business’s financials. Just imagine: suddenly you’re paying half the interest rate, managing five times the loan amount, or dealing with monthly instead of daily or weekly payments. These benefits will change how you run and grow your business for the better.
Don’t be afraid to refinance your short-term loan if that means more capital, lower rates, or longer terms but be careful not to get stuck with debt you can’t repay. So long as you’re thoughtful of your financial situation and aware of your options, refinancing can go a long way to help your business grow.