Refinancing an expensive short-term product into a term loan

Refinancing daily debits into a monthly amortising payment can transform a business's cash position without changing anything about its trading. It is also harder to arrange than it sounds, for four specific reasons.

Obstacle one: the coverage ratio the short-term debt created

A new lender computes debt service coverage including the obligation being refinanced. If the daily debits are large, the trailing coverage looks poor precisely because of the thing you are trying to fix.

Some lenders underwrite on a pro-forma basis, calculating coverage with the new payment replacing the old debits. Whether that is acceptable is a policy question that varies by institution, and it is worth asking directly and early: will you look at this pro forma, or on trailing figures only? The answer determines whether the application is worth preparing.

Obstacle two: lien position

If the short-term funder holds a UCC filing on all assets in first position, a new lender either has to be paid ahead of them, obtain a subordination, or accept a junior position. Many credit policies decline the third option. Where the refinance pays off the existing position in full at closing, this usually resolves itself — but it has to be sequenced, with a payoff letter and a commitment to terminate the filing. See payoff letter and UCC termination.

Obstacle three: the payoff figure

On a simple-interest amortising loan, the payoff is the outstanding principal plus accrued interest, and it is roughly what you expect.

On a precomputed product, or one quoted as a total repayment, it usually is not. Illustrative only — $50,000 funded, $61,500 total repayment, 12 monthly payments of $5,125. After seven payments you have paid $35,875 and the contract shows $25,625 remaining. Any rebate of the unearned charge is a matter for the agreement, and on many such products it is discretionary rather than formulaic. The refinance has to be sized to the actual payoff quote, in writing, dated, with an expiry.

Get payoff letters for every position before you apply. A refinance approved for the wrong amount does not close.

Obstacle four: the explanation

An underwriter looking at a business that took short-term financing wants to know why. A specific, documented reason — a large customer's insolvency, an equipment failure, a one-time build for a contract now delivered — is a normal credit conversation. "Cash was tight" invites the question of whether it still is. Prepare that answer with evidence, and prepare the second one too: what has changed so this does not recur.

What makes it work

• Move early. One position, taken recently, with an otherwise clean operating account, is a refinanceable file. Three stacked positions and a pattern of overdrafts is not.
• Do not stack while arranging it. Each additional position reduces coverage and adds another payoff and another lien to clear.
• Bring collateral if you have it. Equipment, receivables or real estate can move a file from cash-flow-declined to secured-approved at a workable size.
• Bring current bookkeeping. Interim financials, a complete debt schedule listing every position, and reconciled bank statements.
• Consider a guaranteed programme. Government-guaranteed lending has been used to term out higher-cost debt in some circumstances, subject to programme eligibility rules that are specific and change — see SBA loan programmes and check the current requirements.

What to be careful of

A "refinance" offered by another short-term funder is frequently not a refinance into cheaper money. It may be a new advance that pays off the old one and extends the term at a similar or higher total cost, or a reverse consolidation that adds a weekly deposit alongside the existing debits rather than replacing them. Compare the total dollars repaid and the annualised cost of each, not the daily payment. A lower daily number with a higher total is not a refinance, it is a rescheduling with a fee.

The pro-forma calculation, worked

Illustrative only — cash available for debt service of $180,000 a year. The business is paying $14,000 a month in daily debits, which is $168,000 a year, plus $1,400 a month on an equipment loan, which is $16,800. Trailing debt service is $184,800 and trailing coverage is 0.97 — below one, which no conventional credit policy approves.

Now the pro forma. Refinance the short-term balance into a $120,000 term loan over 60 months at a nominal 11%. The payment is $2,609.09, or $31,309.09 a year. Add the equipment loan and total debt service is $48,109.09, giving coverage of 3.74.

Same business, same revenue, same day. The only thing that changed is the shape of the obligation, and the ratio went from unfundable to comfortable. That is the entire argument you are making, and it is worth setting out on one page rather than hoping an analyst constructs it for you.

It also shows why the answer to "will you look at this pro forma" decides everything. On trailing figures the file is a decline. On a pro forma it is straightforward.

What the refinance frees, and what to do with it

The same illustration releases $11,390.91 a month that was leaving the account.

Have an answer ready for where it goes, because you will be asked. "It stays in the business as working capital" is weaker than a specific one: rebuilding a payables position that has stretched, covering the seasonal trough that caused the original problem, or funding the receivable growth that came with the contract you just won.

Decide it in advance for your own sake too. The most common outcome after a successful refinance is that the freed cash is absorbed without anyone noticing, and the business arrives back in the same position eighteen months later with an amortising loan as well.

How to tell whether you are close enough to try

Four signals, all checkable from your own records:

• One short-term position rather than three.
• No returned items or overdrafts in the last three months.
• A specific, documented reason the short-term borrowing happened, and evidence it is behind you.
• Collateral of some kind, or a guarantor with real personal credit.

Three of the four true, and the application is worth preparing properly. Only one, and the honest first step is three months of repair work — clean statements, no new positions, a current debt schedule — before anyone will look at it seriously.