Using a cash-out refinancing of your home to pay off a business loan
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Dear Your Business Credit,
We have a business loan that was taken out when our business was doing well. With the new economy, our business is doing about a fourth of what it was. The loan is at $40,000 and a high interest rate. We have refinanced our home at a much lower interest rate and have taken out cash to clear our business debt and credit cards. Since our bank has made a lot of dollars on our business loan, I would like to know how to reduce what we pay every month with a cash payout. Is this a possibility? Thanks. -- Jim
It's smart to do your homework in a situation like this. From your description, it sounds like you have done a cash-out refinancing, in which you have taken money out of your home while increasing the debt load. Congratulations on getting an attractive rate.
However, before you rush into refinancing your small-business loan with the money, there’s a risk to consider. A cash-out refinancing is a secured debt, notes Rob Purnell, who works from Belmont, Calif., as vice president of mortgage lending with Guaranteed Rate, a provider of home loans and mortgage financing. “It’s secured by your home,” he explains. “If you default on this loan, the bank will foreclose on you and you will lose your home.”
But let's assume you can stay current on your business loan -- even with declining revenue. You still may not come out ahead financially through this type of refinancing. By stretching out your payments on the debt through the cash-out refi, you’ll get lower monthly payments. You should also benefit from the tax deduction for home mortgage interest. But extending your debt could cost you in the long run. “You might be paying more interest over time than you otherwise would,” says Purnell. Look closely at the terms of your loans and do the math before you leap.
That brings us to your business. Currently, you have what Nat Wasserstein, a crisis manager with Lindenwood Associates in Upper Nyack, N.Y., and New York City, calls an “upside down” balance sheet. You have too much debt relative to the sales you’re taking in. That’s because you took out the loan at a time when you had 75 percent more revenue.
In a scenario like this, Wasserstein says the best course is to look for ways to get rid of the debt entirely and not just stretch it out by refinancing it. In an ideal scenario, you’d figure out a way to bring in a lot more money, so you could retire the loan by paying it off.
How do you do this? Try brainstorming with your business advisers to come up with a new product or service that’s more profitable than what you are selling now -- or do more to spread the word about what you sell -- something you need to think about, anyway, if sales are a quarter of what they once were. Taking a second job for a while may help you come up with cash to invest in growing your business by marketing it more aggressively.
Entrepreneurs struggling with a crushing small business loan that they can no longer afford may want to consider another option: a “workout” or restructuring of the debt with the bank. Essentially, you need to alert the bank that you no longer have enough revenue to support the loan payments. This may enable you to negotiate an arrangement in which the bank forgives part of the debt so you can improve the balance sheet of your business.
Why would a bank do this? A lender would rather you keep the business open than go out of business, he explains. If you close your doors, the bank will likely have to liquidate the business and will probably walk away with less money than if you keep working and making loan payments. “It’s a risk management issue for the bank,” Wasserstein says.
However, this is not easy to orchestrate if it looks like you have some other means to pay the debt. “A bank workout when a business is doing that poorly is unlikely if the individual can afford to pay the loan as is,” says Jeff Stibel, chairman and CEO of Dun & Bradstreet Credibility. In your case, given that the loan is for $40,000 and not, say, $1 million, the bank may not buy an argument that you can’t come up with the money somehow.
As to how a workout would affect your credit, this isn’t a cut-and-dried issue. “It depends on the type of workout and whether it is characterized as a personal loan [meaning personally guaranteed] or pure business,” says Stibel. “In many cases, it won't be reflected negatively at all. For others, it could remain on a credit report for years.”
Anyone looking to do a workout would need a turnaround professional to make a strong financial case to the bank that you cannot generate the necessary sales to pay down the loan, Wasserstein says. Once the bank has that information, it is under obligation to write down the loan, he says. “They have no choice,” he says. “They can’t lie to bank regulators when evidence is being presented to them that a loan is no good.” Once a bank writes down the loan, it is a lot easier to forgive, he says.
If you want to go this route, don’t just walk into your bank and try to negotiate the terms yourself. This is a complex negotiation, and you need a financial professional with experience in restructuring a business on your side, Wasserstein says.
As in many areas of financial services, some professionals in this area are more reputable than others. He suggests that if you're considering a workout, you turn to a well-respected attorney in your community who handles business bankruptcies to see if he or she can recommend a good turnaround professional. The Turnaround Management Association, a nonprofit group with more than 9,000 members, is another potential source.Having interviewed several entrepreneurs who have gone through a workout at a bank over the years, I can tell you that it was extremely stressful for many of them. The bank may play hardball. But for those mired in staggering business debt, it may be worth enduring. You could emerge with a much lower burden of debt and that could save your business. Good luck -- and please check back in and let me know how you’re doing.
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