Should you renew your small business loan? Learn what a loan renewal is, how to renew a loan and what fees are involved.
What’s a Commercial Loan Renewal?
A loan renewal, by definition, is a financing agreement based on an existing loan pact that is nearing its original maturity date. The renewal creates a new agreement with a new loan amount and new maturity date under terms and conditions that otherwise resemble the original agreement. The amount is often the same as that of the original agreement, although it may differ.
Loan Renewal: An Example
Let’s say you take out a loan for $50,000 with a 12-month term, and the loan contains a renewal clause that if you make all your payments on time, at the end of the 12 months, you could renew it for another $50,000 for another 12 months under the same terms.
As the end of the 12 months approaches, you then successfully apply for a loan renewal and receive another $50,000 loan with a 12-month maturity date under the same terms and conditions as the original loan.
What Stays the Same under a Loan Renewal and What Changes?
The main changes under a loan renewal agreement are that the loan now has a new balance along with a new maturity date. If you haven’t finished repaying your original loan before renewing your loan, the renewed amount will include unpaid principal and interest due from the previous loan.
Terms such as interest rates, repayment plans and late fees typically remain the same as the original agreement, although in some cases these types of items may be adjusted. For instance, if your credit score has improved in the past 12 months, you may receive a better interest rate on your new loan.
Why Loan Renewals Are Used
A loan renewal option often serves as a way for lenders to test the creditworthiness of borrowers by initially only extending them part of the amount requested.
For instance, if a borrower wanted $100,000 but the lender was only willing to lend them $50,000 upfront because of concerns about credit risk, the lender might agree to build a renewal clause into the loan. This way, the borrower can apply for another $50,000 at the end of their loan’s maturity, after demonstrating their ability to repay the first $50,000 and reducing the lender’s concern about risk.
Loan Renewal Clauses
A loan renewal normally builds upon terms in clauses set forth in the original loan agreement, although you may sometimes be able to negotiate a renewal clause into an existing contract. A loan renewal option clause outlines the terms that must be met for renewing the loan. For instance, a loan renewal clause may state that the borrower has the option to renew the loan at maturity provided that they haven’t defaulted upon any of their payments.
A loan renewal clause will often require the borrower to give notice of their intent to renew at a specified period before a loan’s original maturity date. For instance, the clause may state that the borrower must give written notice to the lender of an intent to renew financing at least 30 days before the loan’s original maturity date.
Getting Approved for a Loan Renewal
Before a lender renews your loan, they will normally require you to go through an approval process similar to that when you took out your original loan. In many cases, this means the loan renewal process may be more streamlined since you’ve already applied with your lender before and they’ve already verified some of your information. Online lenders may have more relaxed re-approval processes than conventional lenders.
Lenders evaluate your renewal application with the same due diligence they would your original loan application, so there is no guarantee that you will be renewed for your loan. For instance, if your credit score has gone down since the time of your original loan application, your loan renewal application may be turned down. But if you’ve been keeping up with your loan payments, this will significantly improve your odds of getting your loan renewed.
Loan Renewal vs. Extension
The notion of renewing a loan is similar to that of other financing concepts and terms that are sometimes used interchangeably but aren’t exactly the same thing. For clarity, it helps to draw some distinctions.
Loan extensions are often mentioned in the same breath as loan renewals, but they’re technically different arrangements. With a loan extension, the original loan remains in place, but the maturity date for the loan gets extended for an amount of time agreed upon between the lender and borrower. This stands in contrast to a loan renewal, where the maturity of the original loan becomes the occasion of a new loan with similar terms.
An extension effectively allows a borrower to delay repaying their loan in full, often for an additional fee. Lenders typically use an extension as a way to allow borrowers to bring their loans current without defaulting or going into collection status.
Loan Renewal vs. Rewriting or Modification
Loan rewriting or modification is another concept related to loan renewal. Rewriting a loan involves making significant changes to the terms of the loan. These changes can affect the maturity date of the loan, the amount owed, the interest rate or the repayment plan.
In contrast, loan renewal creates a new loan with a new balance and a new maturity date, while other terms remain similar to the original loan. Loan rewriting involves more extensive changes to loan terms than loan renewal, and it modifies an existing loan, whereas loan renewal creates a new loan similar to the original loan. Borrowers who are having trouble repaying loans may seek modifications that make it easier to repay their loan, such as longer terms, lower rates or even a different type of loan.
Loan Renewal vs. Refinance
Loan refinancing is another type of loan arrangement similar to loan renewals but distinct from them. When a loan is refinanced, the original loan agreement is canceled, with any existing debt rolled into a new agreement with new terms.
Both loan renewals and loan refinancing involve the creation of a new loan. With loan renewals, the terms of the new loan are similar to the original. With refinancing, however, the terms can be considerably different. Loan refinancing may be used for purposes such as allowing a borrower who is struggling to repay their loan under its original terms to pay it off under new terms.
Loan Renewal: What Are the Benefits?
Whereas other loan changes such as extensions, modifications and refinancing typically serve as measures to help borrowers who are having difficulty repaying their loans, loan renewal can benefit borrowers who aren’t facing any repayment difficulties.
Renewing your loan can result in major benefits, including:
Access a Larger Loan Amount
Agreeing to a loan with a renewal clause can enable you to secure a larger loan amount than you would normally qualify for. A lender who isn’t willing to lend you the entire amount you want immediately may be willing to effectively split the amount over two or more loans through a loan with a renewal option. By repaying your loan’s original terms, you demonstrate that you are a responsible borrower. This increases your lender’s willingness to extend you the entire amount you originally wanted, spaced out over multiple loans.
Gain Access to Funds Earlier
Applying for a loan renewal may enable you to access funds at an earlier date than you otherwise would. Some loan renewal clauses allow you to apply for a renewal well before your original loan matures. This can be advantageous if you need quick access to capital.
Delay Interest Payments
When you split a loan amount over one or more renewals, interest that you would have normally paid at your initial loan’s maturity also gets split up over multiple terms. This allows you to pay some of the interest later than you would have otherwise, which can help you manage your cash flow.
Raise Your Credit Score
A loan renewal can help boost your credit score. Credit bureaus base your credit rating on several criteria, including your history of paying debts on time as well as your record for responsibly handling a mix of different types of debt, such as student loans, credit cards and bank loans.
Taking out a loan with a renewal clause can help your credit score in both these categories. It gives you an opportunity to demonstrate that you handle loan payments responsibly. It also adds another type of debt to your credit mix.
Leverage More Favorable Loan Terms
A loan renewal can provide you with leverage for negotiating a loan with more favorable terms. Repaying your original loan on time can demonstrate your creditworthiness to your lender and persuade them to offer you a loan renewal with lower rates.
By raising your credit score, it can also help you secure more favorable loan terms from another lender. In turn, this can serve as additional leverage to convince your lender that they’re better off giving you more favorable renewal terms than losing your business to another provider.
How to Renew a Loan
Applying for a loan renewal generally involves the same process as applying for an initial business loan. However, a few additional considerations come into play that can add a step to the process.
Step 1: Apply for a Loan with a Renewal Clause
Normally, a loan renewal is based on a clause in an original loan. You can significantly improve your chances of a loan renewal if you start out by applying for a loan with a renewal option.
However, in some cases, lenders may be willing to add an option to an existing loan if you’ve been making your payments on time. If your current loan doesn’t include an option, you can try asking your lender for one.
Step 2: Make Your Loan Payments on Time
To qualify for a loan renewal, you will need to meet your payments for your original loan on time. This demonstrates to your lender that you are a responsible borrower and they aren’t taking on a high risk of default by extending a renewal offer to you.
Step 3: Optimize Your Credit Rating
In addition to making your payments on time, you can take other steps to improve your creditworthiness in the eyes of your lender. These include:
- Paying bills on time
- Paying down balances on credit cards and other debts
- Checking your credit report to make sure it doesn’t contain any errors
- Depositing more money into your business bank account to keep your average bank balance high
- Reviewing your financial statements with your accountant to see if adjusting any items could improve your performance numbers
- Considering whether you have any collateral
- Making sure your business is current with state and federal authorities on all annual reports, licenses and tax filings
- Rereading the terms of your loan contract to make sure you aren’t violating any conditions that could affect your renewal qualifications
Taking these steps before you apply for a loan renewal can improve your chances of obtaining one.
Step 4: Compare Your Options
If you’ve been responsible about making your loan payments, your credit score may have improved since you applied for your original loan. Your score or your revenue level may also have improved for other reasons, making you eligible for new financing options. Before applying for a loan renewal, compare your other options to determine if a loan renewal is your best option.
Step 5: Submit Your Application
If it looks like a loan renewal is your best financing option, contact your lender about submitting an application. Different lenders may have different requirements on what qualifications and paperwork you will need. Some lenders may have minimal requirements, while others may require more substantial qualifications and paperwork.
Additionally, different lenders and loans may have different policies on when you can apply for a loan renewal. Some may allow you to apply for a renewal as early as halfway through your original loan term, while others may require you to wait until most of your original loan is repaid. The renewal process can take time as your lender reviews your finances, so don’t wait until the last minute to begin the process.
Loan Renewal Fees: What Are They?
Since a loan renewal is essentially a new loan, renewing your loan can incur the same types of fees involved in applying for an initial loan. These can include application fees, origination fees, processing fees and other charges. However, your lender may have a policy of waiving some or all of these fees for renewal, or they may be willing to waive them upon request. Check with your lender for details.
Additionally, if you renew a loan before you finish paying off your initial loan, you will be responsible under your renewed loan for repaying any unpaid principal and interest from your original loan. Before agreeing to a loan renewal, check with your lender how your obligations under your initial loan may carry over into your new loan.