How Low Can You Go?
When David Letterman took over the reins at Bonfatto's, his family's sandwich shop, in 1999, he quickly sensed the growth potential for the business that his grandparents started after immigrating to the U.S. from Italy. Business was so good that the following year he opened a full-service restaurant and bar. In 2005, he expanded again, opening an adjacent lounge for meetings and special events. But success came at a cost--the Bellefonte, Pennsylvania, entrepreneur found himself juggling three different loans and growing increasingly frustrated with the fees his lender was charging.
"[The loans] were all due at different times of the month, so it seemed as though I was constantly putting money aside just to pay [them]," recalls Letterman, 48, owner of Bonfatto's with wife Sherri, 46. "The bank was not willing to work with me to help me with the cash flow--[at least not] until they learned I was going to switch banks."
Once Letterman found a new bank, his first order of business was consolidating his debt into a single loan at a lower interest rate. By refinancing the loans into one easier-to-manage sum with lower repayments, the $2 million business has seen its monthly payment decrease by about $3,000. "Doing the consolidation simplified everything," says Letterman.
As Letterman's story illustrates, refinancing short-term loans into longer-term debt can help a company improve cash flow and get a better handle on working capital. It only makes sense, however, if the new financing deal offers better repayment terms and a lower interest rate than the original loan. In other words, you have to save money over the long run to make refinancing worthwhile.
Bear in mind that a lower interest rate doesn't necessarily mean long-term cost savings. Indeed, while you may get a lower interest rate, you could also get saddled with fees that take a large chunk out of any savings you've gained with the lower-interest loan. Some of the most common culprits are legal and loan documentation fees that can run up the cost of refinancing. "[There are] other terms and conditions that may be in a loan agreement [that] are important to look at," cautions Donna Holmes, director of the Penn State Small Business Development Center. For example, perhaps your previous loan had no prepayment penalty, but your refinanced loan would.
Letterman knows firsthand the importance of finding out whether a loan carries a prepayment penalty. "We had to pay quite a substantial amount in penalty [fees] for early repayment when we did the refinancing," he says. "We did pay the fees because it was worth it to us in the long term. When we got the refinanced loan, we made sure that there were absolutely no penalties for making extra payments or paying off the loan early."
The Right Choice
Finding a reputable lender is just as important as reading the fine print on the loan document. "You have to do your research," says Holmes. "Some [lenders] could take advantage of a business owner who is out there just trying to get refinanced." For example, some may squeeze in additional fees or offer an unreasonable interest rate, Holmes says.
Once you find a lender, you'll need a strong credit history to show that you're not only a good borrower, but also deserving of better repayment terms than your original loan provides. "Banks price their loans according to risk," says Holmes. "So if you're in a cash-flow crunch or in an emergency situation, a bank may do a refinancing, but they're not going to give you the best rate because the risk to them may be higher."
Crystal Detamore-Rodman is a Charlottesville, Virginia, writer who covers the small-business finance market.