Should I Pay off my business loan early – four things to consider
Paying off your business loan early can be a good idea if you have the cash available, providing that it’s cost effective and doesn’t negatively impact on your business.
You need to consider the pro’s and con’s of parting with a lump sum of money.
- What are the overall savings on paying off your business loan early, is it expensive, do early exit fees cost more than the saved interest?
- Could it be more expensive than your current loan if you need to borrow again in the future?
- What is the overall impact on your cash flow of paying off the loan on your business finances, both short and long term?
- Would it be more beneficial if your readily available cash was invested back into your business, rather than paying off the loan?
Will it save you money?
If your business is currently cash rich, then it could be a good idea to pay off your business debts.
Paying off your loans could save you money based on the amount of interest you would be liable for on the remaining loan term.
However, these savings could be wiped out if you need to pay any early exit fees.
Many lenders will charge early exit fees, but the amount, usually a % of the remaining balance will vary between lender, loan type and remaining loan term. Some lenders will actually give you a discount on the interest outstanding if you are paying off early. Ultimately, if a lender provides a loan then they generally will need some kind of return on their money, however, if you are paying off the loan early this means the lender is getting their money back quicker than originally agreed.
Some lenders will offer a fixed monthly repayment, which is the total capital amount plus total interest spread equally over the duration of the loan.
Others will charge higher interest and lower capital at the start of an agreement and then gradually reduce the percentage of the total interest paid and increase capital throughout the duration of the loan.
The blending of interest payments with capital repayments is known as amortisation.
Although the amount you would pay each would be the same with either repayment type, how much you owe on the capital amount varies depending on where you are in your payment schedule.
This is an illustration and each lender’s terms will be different. You should read all the terms and conditions prior to committing to any facility to ensure you understand the terms of the agreement and seek professional advice if necessary.
Could it be more expensive to borrow in the future?
You need to consider your current finance terms, if you have a loan agreement with favourable terms, it could be more expensive to borrow in the future.
Finance agreements and terms are offered based on your company’s current financial status and current finance market conditions.
Lenders will look at a range of factors:
- Financial stability
- Credit score
- Debt levels
- What the funds are being used for and how this will benefit your business
If your company profile wasn’t particularly strong when you originally applied for finance but is now in a better financial position, then you could be eligible a for business loan with better terms in the future.
Success and financial stability are hard to predict, even with the most thorough market research and cash flow forecasting because no one can tell what the future will bring.
Your company could become more stable and profitable in the future which could lead to more favourable terms, however it could go the other way resulting in more expensive borrowing should the need arise.
In addition, finance market conditions will have a big impact on terms, approvals and lending amounts due to interest base rates and lender appetite. Another thing to consider is if your business sector has been impacted positively or negatively then this could have a knock on a effect to lenders appetite.
How will it affect your company’s finances?
Cash flow is king and having cash in the bank is good for any company. Cash reserves always come in handy as they can cover unexpected expenses, give you spending power to take advantage of supplier promotions or cover quiet months for seasonal trade.
Having cash in the bank offers your business financial security to ensure smooth and efficient running of your business.
Although cash in the bank is nice to have, it may be worth paying off your loan if:
- You know you can raise funds quickly to cover unexpected expenses
- Your interest rate on your loan is higher than interest on savings
- You are a seasonal trader entering your busier months
- You will have enough cash for security left over after paying your loan
It may be better to hold off paying off your loan if:
- You have a low interest loan
- You will have enough cash left over after paying off the loan
- You are close to the end of your loan agreement
- Is it likely to be more expensive to borrow again in the future
As all businesses are different, you may place more emphasis on different points outlined above, regardless of which you prioritise your needs to ensure you have thought at length about which is the best course of action for your business.
Could you use the cash for other purposes?
Having surplus cash and pumping it back into your business can be great way to improve efficiency and profitability. There are range of areas that could benefit from increased spending, such as:
Expanding your business can be costly and time consuming, however when done correctly it can be highly beneficial in driving higher turnover and profits. Expanding your business should enable you to increase your customer base, profits and reach.
It is worth drawing up cash flow forecasts to keep on top of your income & expenditure and make financially driven decisions when expanding. It is very easy for costs to increase and for you to blow your budget.
Companies must keep up to date with market trends, new technologies and legislations. In order to do this, they must invest.
Investment is extremely important for companies looking to increase competitiveness, efficiency and profitability.
Whether it is for marketing, stock, R&D, business premises or new equipment and machinery, having readily available cash can make investment much easier.
How much you need depends on where you need to invest. It is worth calculating how much your investments will cost and what the long-term benefits are.
Diversifying into next market and sectors a great way to increase your business security. Being able to tap into different markets can help you to keep on top of market trends and the ebbs and flow of consumer demand.
Whenever you decide to diversify, you must make sure that you have experience in the new market you are moving into.
Without knowledge and experience you will find it difficult to thrive and compete against those with more knowledge.
So, if the benefits of putting the cash back into your business outweigh the benefits of paying off your loans early, then it may be better to keep the cash and invest.
In summary, there is no clear-cut answer to whether you should pay off your business loans early, you need to make sure that it is a financially sound decision and you have considered all the positives and negatives involved.
Key points to remember are how much will you save, could you use the cash elsewhere and what are you borrowing options for the future should the need arise?