As interest rates change and cash flow comes and goes, you might consider refinancing your commercial loan in order to save money. Refinancing a commercial loan is similar to a personal mortgage; you will use that money to pay off your original loan by applying for a refinance loan.
There are many other reasons to refinance your commercial loan, but usually, the goal is to lower your monthly payments or change your loan terms to something better. You can also refinance to improve the property or invest in a new one.
Before you start to apply for a new refinance loan, there are several considerations to take in, including the costs and lending requirements needed.
What Does it Mean to Refinance a Commercial Loan?
Commercial loans are loans from banks or other financial institutions to help fund a new or existing business. Refinance a commercial loan means applying for a new loan from the same or different lender that will pay off your existing loan.
Many people choose to refinance to improve the terms of the loan, increase cash flow, and save money. The new refinance commercial loan will ideally have better loan terms, such as:
- Lower interest rates
- Different, better payment periods
- Lower monthly payments
- Longer repayment period
Although most people are able to refinance commercial loans, it’s important to understand the qualifying terms when seeking refinancing. For example, if you have a traditional term loan and want to refinance it into an SBA, you have to meet all the requirements set forth for the SBA loan and not just the requirements from your original loan. Although it’s a refinance loan, it is still its own loan.
Pros of Refinancing a Commercial Loan
The goal and benefits of refinancing a commercial property loan are improving loan terms, increasing cash flow, saving money, or investing in other properties.
Improve cash flow
One of the most common reasons people choose to refinance their commercial loan is to improve their overall cash flow. If interest rates are lower than when you first accepted the loan, it is possible you will be able to get a lower interest rate on your new loan, freeing up extra money.
A business owner can also choose to do a cash-out refinance by tapping into the equity of their commercial real estate. This cash can then be used for almost anything if the terms are right.
Lock in lower interest rates
Along that same line, when you refinance a commercial loan with lower interest rates, you can lock in that rate to avoid higher ones in the future with a good-faith deposit upon submitting your application. By locking in a lower interest rate, you can ensure you have the extra cash flow and not worry about refinancing every few years when the rates adjust.
Overall better loan terms
When you refinance your commercial loan, you can adjust the terms to work better for you, including shortening or lengthening the loan repayment terms or changing your loan type. If you need more time to pay off the loan, for example, you can get a commercial loan with a longer amortization period, even up to 30 years.
Avoid balloon payments
Unlike some personal mortgages, commercial loans generally require a balloon payment at the end of its term. A balloon payment structure occurs when a loan has regular small monthly payments followed by a single, often much larger, sum at the end of the loan period. In some cases, the monthly payments only cover the interest of the loan, while the final payment is the principal of the loan.
Refinancing a loan avoids balloon payments for business owners as the loan is paid off before it can reach that final payment date. Even small mom-and-pop business owners turn to refinancing as a way to not get trapped in a balloon payment.
Expand your investment portfolio
Refinancing commercial loans allows many buildings to expand their real estate portfolio and grow their wealth. Often, real estate investments have accrued equity over time, allowing owners to pay off their original loan amount and have leftover money on the new, refinanced loan to buy other properties. For example, if a building owner bought a property ten years ago for $500,000, but the property is now worth 1 million dollars, they can get a refinance loan for that 1 million, pay off the rest of the original loan, and still have $500,000 to purchase a new place.
Cons of Refinancing a Commercial Loan
While there can be great benefits to refinancing a commercial loan, there are some drawbacks to the process that you should factor in as well.
Upfront fees and costs – If you are refinancing your loan for the first time, you may run into some large closing costs and other fees. After all, refinancing is essentially taking out a new loan. To avoid any surprises, make sure you understand the costs associated with refinancing a commercial loan by speaking to your lender, who can help you navigate the process.
It may not save you money – Most of the time, refinancing will have some financial benefit, but if you are already struggling to pay your current loan, refinancing may not be the choice for you. Instead, look for cash-flow problems and talk to your lender about adjusting your payment schedule.
Prepayment penalty – Depending on your lender, you may face a prepayment penalty for paying off your original loan early. This includes SBA loans as well. Be sure that the savings of your refinance loan can cover the cost of the penalty.
Types of Commercial Refinance Loans
There are three main types of commercial refinance loans to keep in mind when you want to refinance your current loan. Each one will have different requirements for approval. Which type you choose will affect the interest rates and terms you will have, so be sure to research each type thoroughly before choosing.
Government-backed refinance loans
SBA loans and USDA agriculture loans can provide refinancing for commercial loans. The process for applying for these loans is the same as a traditional commercial refinance loan, except the government backs the loans. The guarantee provided by the government allows these types of loans to have flexible qualifying standards and lower interest rates. Refinancing with a government loan, such as the SBA 504 loan, is a good way to ensure you’re getting excellent loan terms that will help lower monthly payments.
Traditional commercial refinance loans
Found through credit unions and banks, traditional commercial refinance loans refer to term loans that are granted through a traditional financial institution; they can also be referred to as conventional commercial refinance loans.
These loans often don’t have specific loan limits but rather a percentage of the value of the property. The property acts as collateral to secure the loan. Refinancing with a traditional loan allows borrowers to change their loan’s interest rate and adjust the loan terms, such as getting a shorter loan term than their original one.
Commercial cash-out refinance loans
Cash-out refinance loans are preferred for those who are refinancing their commercial loan to invest in more properties. A cash-out refinance loan allows you to replace your original mortgage with a new one by borrowing more money than you owe. Once the property is paid off, the rest of the refinance loan is paid to you in cash. If you have a lot of equity built into your property, a cash-out refinance loan is a good option to build wealth or expand your portfolio.
What You Need for Refinancing a Commercial Loan
When you are ready to refinance your commercial loan, you should keep a few key requirements in mind.
Credit score – Almost every loan will require a good or excellent credit score, both in terms of your personal credit score and your business credit score. For example, the SBA has a required minimum score of 155 out of 300 for their SBA (7a) loans. The higher the score, the better.
NOI – NOI, or net operating income, measures the property’s gross income minus its operating expenses. Similar to your credit score, the greater the NOI, the better the chance of refinancing your commercial loan.
Operating history – Most lenders want to see a business that has been operating for a few years before refinancing. If you are refinancing in the first year or two, that’s usually not a good sign to the lender that your cash flow is good, and the health of the business may be questioned.
Above all, make sure your financial well-being is in good health before applying for any refinance loans and understand what type of loan you want to apply for. Each type of loan will have different requirements.
Fees for Refinancing a Commercial Loan
One of the biggest drawbacks when refinancing a commercial loan is the fees that come with a new loan. As they are a necessary part of the loan, it’s important to plan for them so that you understand the total cost of refinancing and whether or not it will be worth the process.
The typical fees that come with refinancing a commercial loan include:
Appraisal fee – To assess a property’s current value, a third party will need to look at it and estimate its value based on the size, age, and location of the property. Appraisal fees vary but can range from $1,000 up to $10,000 on a commercial property.
Credit checks & underwriting processing fees – Before an application is approved, a lender must run a credit check and do background information through an underwriter to ensure the borrower isn’t a risk. These fees vary by lender but can be from $600 – $3,000 combined.
Origination fee – Lenders charge origination fees to charge for the work of completing the application. This is usually not a set number but rather a percentage of the loan, typically about 1% of the loan amount.
Guaranty fee – If you are looking to get an SBA loan, be sure to include a guaranty fee, or upfront fee, in your calculations. A guaranty fee is charged by the SBA, between 0.25% and 3.75%, for backing the loan.
Prepayment penalty – The prepayment penalty can be one of the highest costs when applying for a refinancing loan. Many lenders will charge a prepayment penalty to pay off your original loan early, and it can be as much as 5% on SBA loans within the first year of the loan. Over time, though, that percentage does decrease; if you can hold off refinancing for another year, it may be worth it to avoid an expensive penalty.
Is Refinancing a Commercial Loan Worth it?
Refinancing a commercial loan does come with some fees and penalties that can cost a borrower some extra money. Still, refinancing is a good option for those looking to save on monthly payments, lower interest rates, or even for those looking to expand their portfolio of properties.
If you are in a healthy financial situation with your commercial property, it can be helpful to refinance your loan to avoid balloon payments. However, if you struggle to make payments on your current loan, it’s important to talk to your lender before refinancing. They will be able to work with you on the payment due dates and help evaluate your situation.
Note: Links to other websites or references to services or applications are provided as a convenience only. A link does not imply SouthEast Bank’s sponsorship or approval of any other site, service or application. SouthEast Bank does not control the content of these sites, services or applications.
Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.