As we close out Q3 of 2024 and enter Q4, you may be considering a few credit changes in your budget. Given the year-end forecasts, it may be time to refinance and reduce those commitments. Whether refinancing is right for your business depends on your reasons for seeking financing and the current state of your business. You don't need to wait for the results of the September Fed meeting to start preparing.
Market Situation
So far this year, the Fed has changed interest rates at least once for the better or for the worse. However, the Fed decided in September to begin cutting its first rate of 50 basis points or half of 1%. Some economists expected a reduction of only 25 basis points, while others expected 50. This change lowers the Prime Rate from the 8.5% we saw since July of last year to 8%. And it's the only decline expected in 2024.
The Congressional Business Office, which provides budget analysis for Congress, projects an unemployment rate of 3.9% and inflation of 2.7% in Q4. It also expects economic growth to slow over the next two years. Financial advisory firm Vanguard expects a key measure of inflation, called the core PCE index, to rise from its current rate of 2.6%, which was affected by last year's price comparison. The labor market, however, should remain strong throughout the year.
What That Means for Financial Recurrence
Given the economic forecast for Q4, it is time for businesses to prepare for refinancing as the rate cut in September could lead to better than current lending conditions. Since inflation, companies may face low input costs, but it is not enough to pay the debt. Refinancing debt can help businesses manage it more effectively. Given the expected slow economic growth, locking in low interest rates by refinancing before the end of the year would be a smart move. This ensures low debt service costs in a potentially weak economy.
Repayment Benefits
If you're on the fence about refinancing, there are significant cost savings to be had when you do so:
- Since your current debt is required, you may be expected to make a balloon payment to cover it, depending on the type of loan. However, if current economic conditions make that unviable for your business, refinancing can help you avoid it.
- Having a high-interest loan can lower your score. If you refinance a low-rate loan, it can raise your score. If your business was new when you got your first loan, building up more experience from there may mean you qualify for a lower interest rate.
- If your current loan no longer serves your purposes, you can change the type of loan you have by refinancing. For example, eliminate high-interest debt from short-term financing by refinancing with a long-term mortgage.
- Refinancing from a floating rate mortgage to a fixed rate can lock in rates before they rise again. Fixed rates also make it easy to plan and budget, knowing exactly how much you'll need for every payment.
- You can achieve equity by refinancing to fund expansion projects. A new loan, based on your current income, pays off the original loan, and provides liquidity.
Overall, when businesses continue to seek refinancing, lenders are pressured to offer competitive rates, which benefits you and other small businesses.
Example of Financing
Many new small businesses choose to be paid a merchant fee to help them with a short-term cash injection. With merchant cash out, you get instant cash without having to endure a rigorous qualification process. When you switch, you agree to give a percentage of future sales to the lender. You end up paying the original loan, and the high interest that reduces your profit. Typical rates can be as high as 50%.
SBA loans are guaranteed by the federal government, so lenders cannot exceed a certain amount. Currently, the amount of SBA 7a loans increases by 15% and decreases the more you borrow. To cement the concept, here is an example calculation for a $200,000 loan. First, let's look at the most common loan taken out by small businesses, the Merchant Cash Advance with an interest rate of around 50%:
$200K x .5 = $100K interest | $200K + $100K = $300K needed to return
Now, let's look at an SBA 7a revolving line of credit with an interest rate of 15%:
$200K x .15 = $30K in interest | $200K + $30K = $230K total cost
As you can see, refinancing an SBA loan represents a much lower cost to your business than maintaining an original MCA. Additionally, an active cash line of credit allows you to pay it off on your schedule (either increasing or decreasing your cash cost based on your payment timeline). A revolving line of business credit allows you to draw on it whenever needed, providing a safety net for your business.
With an active $200,000 line of credit a business can save $70k a year and have a better tool to support their business compared to taking out an MCA loan.
Preparing for Refinancing
If you've decided to refinance, your best bet is to do it before the end of the year. Given that it is an election year, existing incentives for certain types of projects may end or change depending on the new administration. The results of the election will affect the market, regardless of who wins, making it difficult to predict the economy of 2025.
Your first steps in refinancing should be to gather your paperwork and review your current loan. You will need to understand your current rates before you can look for lower rates. Review your credit history to see if you qualify for lower rates. Finally, check your agreements for any penalties your current lenders may charge for refinancing.
One important thing to remember is that you don't have to think about refinancing on your own. It is important that you do not travel alone. Brokers prove invaluable during the credit transition, offering expert advice, up-to-date loan rates, and customized refinancing recommendations. You'll get all the information you need to make the smartest decision for your company, instead of wasting time on unnecessary bills.
