Money is very essential in running a business and everyday living. Most times, it is insufficient thereby causing one to borrow to expand one’s business or to settle personal demands. These debts are also accompanied by high-interest rates from the lenders. In some cases, banks might require collateral before issuing a secured loan. When a debt is refinanced, there are a few advantages to it.
Refinancing is the process of changing or revising a previously drafted credit agreement with a mortgage or loan. This involves making more appealing changes to certain factors such as the payment schedule, interest rate, and other terms of a loan. When approved, it replaces the original agreement. Debtors often decide to refinance when there are changes that affect the interest rate thereby saving money on the debt owed. Debts on car, mortgage, and student loans are often revised when interest rates depreciate.
One of the key reasons for refinancing is to make adjustments to already existing terms to accommodate the changing economic situations. Other reasons are to extend the term of the gjeld (Norwegian for debt) or even to reduce the fee over the repayment period by lowering the interest rate. Debtors may also refinance when there’s an improvement in their credit profile to settle the existing loan.
Types of Debt
There are different types of debt with each serving a unique purpose. Understanding them will enable you to manage complex financial situations and also coordinate your finances better when borrowing. Personal debt can be divided into two main categories.
This involves pledging property or other assets as collateral for money borrowed. When the money is not paid at the assigned time, the lender is allowed to collect the property. This type of debt usually has a low-interest rate, since the collateral lowers the risks involved. It is also accompanied by a longer repayment period which sometimes guarantees lower rates. Car loans and mortgages are some of the common types. Although mortgage interest is often tax-deductible, that of automobiles is not.
These are mostly bank overdrafts, student loans, medical bills, credit cards, and personal loans for which a contract is signed. Although it doesn’t require pledging collateral, your income and credit history will be examined before the loan will be granted. Interest fees are often higher than the secured type and are usually not tax-deductible.
Types of Debt Financing
Debt financing is made up of a wide range of funding options which is largely affected also by your goals. While established and large businesses can depend on banks to finance their expansion plans, small and medium enterprises must, however, rely on other sources to finance their debts. These alternative sources are not only flexible but make the process easier. Some of the common types of loan financing are.
Financial Institutions Loans
Although this type of loan may be difficult to come by, it is one of the common services provided by traditional financial institutions. Companies however need to scale through a long list of requirements such as robust credit history and long-term investment history to qualify. Banks offer equipment, business, and unsecured long-term loans. While business loans are taken specifically to suit company goals; that of equipment however are tailored towards buying, replacing, or upgrading company assets.
The item purchased would need to show a quick return on the investment. Unsecured loans in contrast to secured ones demand a wide range of financial assessments with no collateral. This type however is not extendable beyond ten years.
Peer to Peer Lending
This type was born with the arrival of sites such as GoFundMe and kick starter thereby becoming a substitute to family funding. This option is suitable for small businesses that are comfortable with publicly publishing their financial information. This however may damage the business reputation if they fail to deliver on the product or return. They also do not offer professional advice and flexibility like other alternative lenders.
Recurring Revenue Lending
Also called Software as a Service credit, it provides money to businesses based on their monthly recurring revenue (MRR). The amount accessible depends on the revenue gotten from customer subscriptions. Loans like this can be borrowed and returned with ease especially since interest is not required when there is no borrowing.
This is a suitable option for businesses with excellent accounts in maintaining recurring services with customers. It is also recommended for those with over 20 percent annual revenue growth. The company’s eligibility is determined by its current and historic revenue streams. This option is ideal for those who wish to fund quick growth without increasing their shareholders.
Non-Bank Cash Flow Lending
Banks often analyze factors such as profit, investment history, assets, and credit history of companies before issuing traditional loans. These companies are evaluated to reduce risk and determine their ability to repay. However, non-bank loans are granted on factors such as the company’s cash flow and the company may also be considered for a loan based on customer return rates, transaction frequency, expenses, online reviews, and seasonal sales.
This debt can then be paid off in sales percentages or as a fixed amount over an agreed period. Although this flexibility is difficult to find in banks, one must be wary of hidden charges and high-interest rates.
Loans From Family and Friends
Most businesses often get start-ups from friends and family members since they are accompanied by more flexible terms, minimal paperwork, and little to no interest rate. There should be an evaluation on the ability to pay back particularly in the event of bankruptcy. This loan should also have a detailed repayment plan to avoid reputational risk and other pitfalls often identified with this type.
This is money borrowed by government agencies, companies, or other organizations. The capital is however generated from investors who purchase them from the organization or business. They can be secured or unsecured and are much different from stocks.
It often requires a legal agreement between both sides. This way, companies that are unable to fulfill their obligation can use bonds to permit substitute investors to be lenders. Short-term bonds are often issued by businesses with urgent needs and they mature within 3 years. Medium-term bonds require over 10 years to reach maturity while long-term bonds need an extended period of over 30 years.
Why You Should Refinance your Debt
Deciding to refinance requires clear goals to avoid being plunged into more debt and undergoing the entire tedious process. There are several reasons to revise your loan agreement to elevate your financial standing. Some of the reasons you may consider refinancing are if it does the following:
Lowers Interest Rate
This is one of the most famous reasons especially for homeowners who often have higher fees on their agreement. Shortening the term of the money borrowed reduces the amount which results in huge savings. Offsetting your mortgage faster allows you to save on interest while lowering the rate too.
Converts from Adjustable-Rate Mortgage (ARM) or Fixed Rate Mortgage
Although an ARM may offer lower rates initially, it may become necessary to switch to a fixed-rate mortgage which may have lower interest charges and remove all concerns of a future hike. This is however a sound decision only when the charges are falling. It will be unwise to do so when the rates are climbing.
Higher Credit Score
Paying off a high-cost loan will boost your credit score thereby increasing your chances of getting a higher loan. This is because the amount made available is dependent on your score. A low score, therefore, translates to high-cost debt while a high credit score means you will get a low-cost debt. Refinancing will help you maintain a high score by offsetting debts in due time.
If you need tips on how to improve your credit score, you can check here.
Certain unfortunate incidents such as a serious accident or death may cause one to refinance. This is because the equity can be regarded as a non-liquid saving that may be converted in such an incident. This may however result in a longer payoff but bear in mind that a home loan usually has a lower credit cost than others. Always consult your mortgage lender to reach a beneficial conclusion.
Removes Mortgage Insurance
Refinancing helps in lowering monthly costs for loans accompanied by private mortgage insurance. While this is a chance for people with little savings to own homes, it also comes with compulsory mortgage insurance. After an upfront payment of 1.75 percent, an annual payment of 0.85 percent is expected for a 30-year period which eventually adds up over time and cannot be canceled. This can however be eliminated by refinancing the loan to a conventional mortgage after attaining 20 percent equity in that home.
Combines High-Interest Debt
A cash-out refinance aids cash flow and improves long-term savings when there is a huge interest bill on personal loans or credit cards by taking a slightly higher loan. This however has some downsides to it such as being unable to minus the interest to be paid on the amount being cashed out on the excess present debt balance if the money isn’t used to improve, buy, or build your home.
Beware of insuring unsecured credit card bills with your house and ensure the new terms are affordable or you run the risk of losing your home. Refinancing can also be done to bring all the debts under one umbrella as one loan.
Getting a loan is usually a difficult process for some business owners since banks will rather lend to established companies with a high success rate than a start-up. Alternative lenders have therefore become a more suitable option for small companies since they are more flexible in meeting their needs and helping them grow than the banks. It is important to bear in mind the likely impact this will have on the credit rating and cash flow of the company.
Companies must be careful of the lenders they borrow from and always opt for a reputable one that has the interest and success of the company at heart. Extensive research should be carried out before choosing a financing partner because some lenders demand extra charges for underutilized credit lines. Refinancing is a huge financial move and should be commended if it shortens your loan term, lowers payment on a mortgage, or builds equity quickly. Oftentimes, it has been used as a useful tool to control debt. However, consider your financial condition before embarking on the journey to refinance. It should only be done after careful thought, for the right reasons, and at the right time.