How Long Should You Keep Your Loan?
Just as there is no one-size-fits-all loan that applies to all business and business needs, there is no one-size-fits-all answer to how long you should keep your business loan. Should you pay it off early if you have the opportunity? Or should you continue on the original path laid out by the loan terms?
The answer to that question will vary greatly depending on your specific loan terms and your business’ financial situation and outlook. But before we dive into the question of how long to keep a loan, let’s look at whether you actually need a business loan.
Questions to ask before seeking out a business loan:
- Are you planning for an expansion that requires an additional infusion of capital?
- Do you need additional working capital? Need new equipment, inventory?
- Is it in your best interest to consolidate debts into one loan?
- Are you now eligible for a loan from a lender that may have passed on you before?
What type of loan does your business need?
Generally speaking, business loans typically fall into one of two categories: term debt or revolving debt.
Term loans, also called “installment loans,” fall into ‘short’ and ‘long’ term categories. Short term equates to one year or less, while long term is anything over one year. A car loan is a good example to visualize here, with fixed monthly payments spread over four to six years.
Revolving debt applies to lines of credit and credit cards. Unlike term loans that are repaid in set, equal amounts over the term of the loan, payments on revolving debt vary based on the outstanding balance. Note that some revolving debt may require full balance repayment each month, quarter or year.
For many businesses, this isn’t a decision of choosing a term loan or a revolving loan. Instead, the business needs and cash flow situation will determine the type of loan that fits best. For example, a business may need a term loan to finance equipment, but may also have a line of credit to fill any gaps in its cash flow cycle.
Next, let’s talk terms and conditions.
Loan “terms” are a combination of the loan amount, rate and the repayment schedule that mathematically combine to reflect how much you will pay per month. That said, not all loan terms are created equal. The longer the term, the lower the monthly payment.
Most businesses seek a low monthly payment, and thereby look for the longest term available. Generally speaking, if you can keep payments low, you can hold onto more cash to cover lulls in business. Alternatively, when business is booming, you can opt to make larger payments to accelerate repayment. (Here’s a quick primer on different loan types small businesses can consider.)
Loan “conditions” outline the rules that govern the loan. Conditions will vary, but there are a few factors that have a significant impact on the cost of the loan:
- Origination fees: These are upfront fees that a lender may charge to cover the administrative costs associated with processing the loan.
- Prepayment penalties: These will matter for both the loan you may seek to repay and the loan you’re considering. Essentially, this is a penalty fee imposed by the lender for paying off your loan early.
If your goal is to secure lower loan payments, make sure you also understand the potential fees and their amounts. There may be other conditions that affect your decision, such as collateral requirements, insurance requirements or the frequency at which you’ll need to provide updated business financial data after closing the loan.
So, how do you find the right lender?
As we’ve discussed before, you want to find the right lending partner for your business. It’s tempting to start with financial institutions that you already have a relationship with, such as a business checking or even a personal deposit account, but you want to make sure that institution makes loans to businesses.
Next, consider whether that institution has the ability to grow with your business. Your capital needs will continue to evolve over time, so you want to make sure the lender has the bandwidth to accommodate your growth.
Are you refinancing debt? Find out if the lender can offer lower rates and better terms. If you’re also looking for additional capital, can the lender both refinance your loan and add more funds to provide that extra capital?
Lastly, do a gut-check. Do you like the lender? Don’t underestimate the power of a good relationship. It’s always ideal to do business with people and companies that you like and who provide more personalized service than those that treat you like a number.
Now, should you pay off a loan early? Consider these factors first:
- Will a refinance reduce your interest expense?
- Is there a prepayment penalty? As we said previously, this fee allows a lender to recoup profit they would lose because of an early payoff.
- Will it improve your credit? A loan reported as “paid in full” can help increase your business credit score, making it easier to obtain future loans with more favorable terms.
- The interest rate on the loan. The higher the interest rate, the more you will pay in interest over time. If you can find a loan with a lower interest rate, you’ll likely save money by repaying it with the proceeds of a lower-rate loan.
- The length of the loan term. The longer the loan term, the lower your monthly payments will be.
- Will it impact your cash flow? Paying a loan off early, particularly with business cash, could strain cash flow and leave you vulnerable to unexpected expenses by reducing your cash reserves. If you are planning to grow your business, you may want to keep the loan in place so that you have reserves as needed. However, if you are not planning to grow your business, you may want to consider paying off the loan sooner to save money on interest.
Ultimately, the decision of how long to keep a business loan is a personal one. You should weigh the pros and cons of each option and make the decision that is best for your business.
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