Important points
-
Prioritizing loan payments within your business budget can help you avoid late payments and defaults.
-
Adjusting your plan based on your actual income and expenses will help you manage your loan during the repayment period.
-
Making extra payments can help you pay off your loan early, but beware of early repayment penalties
You've taken the initiative to take your business to the next level and applied for a business loan. Then it was approved. So, what should we do? Once you've found the right business loan and the funds have been disbursed, you'll need to come up with a plan to manage your loan payments.
Managing your business loans is important because you want to avoid loan delinquencies. As of December 2023, total business loan balances have increased 2.4% since the third quarter of 2022, according to Federal Reserve data. This could indicate a delay in loan repayments, putting small businesses at risk of loan delinquency. Additionally, the delinquency rate for the fourth quarter of 2023 was 1.03, up from 0.97 in the third quarter, according to St. Louis Fed data.
To avoid late payments, you need to know how to manage your business loans and budget, and what to do if you run into financial difficulties.
1. Prioritize payments within your budget
A business budget is a calculated plan for managing your small business's money, including income and expenses. When signing a loan contract, pay attention to the monthly repayment amount. Then, create a plan to set aside this money and prioritize it in your budget over less important expenses.
If you can't make your loan payments, optional travel, investments, or new equipment may not make sense.
Insights on bank rates
Before you commit to a business loan, use a business loan calculator to help you understand your monthly payments and ensure affordability.
What happens if I default on my business loan payments?
If you miss a payment on your business loan, you may end up in arrears. If you default on your loan, your lender may seize the collateral used to secure your loan.
If you don't make enough payments, the lender will send the loan to collections and damage your credit history. At this point, you will be in default on your business loan. Your lender may charge you the balance of your loan along with interest, fees, and penalties.
If you are having trouble managing your loan payments, you may want to consult a business accountant. Doing this early can help you reorganize your finances to maintain loan payments and avoid default.
2. Adjust your plan based on actual revenue
To manage your business loan over the long term, it's important to review your current monthly cash flow. Some months you'll have less income or unexpected expenses, and other months you'll earn far more than you planned.
If your monthly payments are slow, you may need to temporarily cut back on expenses to make the payments. If you have extra income, consider using it toward loan payments or setting aside funds for future loan payments.
Adjusting your financial plan according to your monthly performance is especially important for business lines of credit. With this type of loan, you can borrow as many times as you like up to your available credit limit. Make sure your business can currently accommodate all debt payments, yet have the flexibility to use it when needed. That way, you don't end up using up your entire credit line by not being able to pay it back.
Insights on bank rates
Employer businesses have had to navigate many financial challenges over the past year, according to the Federal Reserve's 2023 Report on Employer Businesses. Of these, 54% are experiencing difficulty paying operating expenses, and a similar proportion feel they have a gap in cash flow. A whopping 81% faced the challenge of rising costs of goods, services, salaries, and more. 42% took action on their economic challenges by taking out a small business loan.
3. Track your spending
Thorough bookkeeping will help you understand your cash flow over months and seasons. You can then use that information to adjust your loan repayment strategy. It also prevents mixing spending categories and misusing loan funds.
If you're new to managing business loans alongside your regular funds, use these tips to help you stay on top of your finances.
- Open a separate business account. Separate your business expenses by setting up a checking and savings account specifically for your business.
- Track your receipt. Receipts help you categorize your expenses and provide evidence of your spending when reviewing expenses or filing taxes. It also helps you find errors in your records.
- Use spreadsheet or accounting software. Organize your business expenses using spreadsheets or specialized bookkeeping software. Tracking allows you to separate debits and credits into separate categories for easier tracking.
- Work with your accountant. If you're a small business and are struggling to manage your money, consider working with an accountant to help you budget effectively.
Over time, keeping records will help you understand your cash flow over months and seasons. You can use that information to adjust your loan repayment strategy. For example, if you often have cash in the middle of the month, that may be the best time to pay off your loan.
4. Make additional payments if possible
If your business has additional revenue, consider putting more money towards your loan than the monthly minimum. Paying extra can save you money on interest over time and help you pay off your loan sooner.
The downside is that you can't reinvest that money into your business or purchases to expand your business. Using our loan calculator, you can compare how much you could save by making additional payments versus by sticking to your payment schedule and freeing up capital.
Let's say you have a $50,000 loan with a 10-year repayment term and an annual interest rate of 6%. Without additional payments, you'll pay approximately $16,610 in interest over the life of your loan. But if you pay an extra $100 each month, your total interest expense will drop to about $13,130, a savings of about $3,500.
Insights on bank rates
If you pay off your loan early, some lenders will charge a prepayment penalty to recoup some of the lost interest. The penalties imposed can range from 1 percent to 5 percent of the loan amount and can significantly offset the interest you save. Be sure to add fees into your business loan calculations to see if the savings are worth it.
5. Refinance if necessary
Refinancing your small business loan can help you take advantage of changing circumstances and save money on your loan. If a better interest rate is available, or if your credit score has improved significantly since you applied for the loan, refinancing may make sense.
But refinancing doesn't make sense if the loan fees are higher than the amount you'll save by refinancing. Typical loan fees include origination fees or loan closing costs, which can range from 2% to 5% of the loan amount. Appraising a property to be used as collateral for a loan can cost hundreds of dollars or more, depending on the type of property. If you're considering refinancing, calculate all the costs and decide if it's the best decision for your business.
Insights on bank rates
Businesses with multiple loans can consider debt consolidation, which allows them to take out one loan to pay off multiple existing debts. Similar to refinancing, this can be a smart choice if the new loan offers better terms. However, this depends on the qualifications of the financial institution and company.
6. Contact your lender
If you are unable to make your loan payments, notify your financial institution of your financial situation as soon as possible. If your financial situation does not improve, your lender may suspend your payments (known as payment deferral) or restructure them into a new term.
In the worst-case scenario, your lender may work with you to consolidate your debt so you can pay off only part of your debt. However, debt consolidation can affect your credit history for several years, especially if you use bankruptcy to resolve your debts.
conclusion
Managing small business loans can be less scary if you know what you're doing. Understanding your financial situation and prioritizing loan payments within your business budget is the key to successful loan management and sustainable business growth.
If your business is experiencing financial difficulties, you can consult a financial advisor or accountant to help get your payments back on track or to determine whether it's time to consider alternatives such as refinancing. Masu.
FAQ
-
Your business should be able to comfortably handle business loan payments within your current budget. One way to consider how much debt a lender can handle is to calculate your debt service coverage ratio. This ratio compares operating income to current debt and divides the sum of the two. Lenders want to see a DSCR of 1.25 or higher to see if you can manage your debt repayments.
-
A business budget provides a detailed list of your business's income and expenses by year, month, and week. Your budget should include not only your actual revenue to date, but also your projected revenue. You should also list all expenses, including temporary, fixed, variable, and seasonal expenses.
-
If you want to save on interest, it is advantageous to pay off your business loan early. Some financial institutions offer prepayment discounts, which can help you save even more. Because most loans calculate interest before each payment, you'll likely need a significant amount of cash to pay off the loan, and you'll run out of capital in a short period of time. That's capital that can be used for growth in other areas. You may also be subject to early repayment penalties, which defeats the purpose of paying off your loan early.