Top Reasons Why Not To Pay Off Your Business Loans Early
However, this isn’t always the case. Most loans come tagged with several caveats especially on early settlement. We look into the case of business loans taken out for business expansion and assess the reasons why you should never pre-pay your loans in advance.
#1 Opportunity Cost
It may not always make sense to pre-pay the entirety of your business loan. Although you may be saving on the amount of interest you have to pay for in your monthly repayments, you lose out on the profit margin to be earned when you reinvest your cash into another project or buying more inventories to sell.
If the business loan interest is 6-8% per annum and your business net margin is 10-30%, This means that you stand to earn more money if you invest in the business than to pay off your loan early.
Even if there are no projects on hand, keeping more cash on hand is always important and this is to ensure you are always cash ready when the opportunity arises.
#2 Early Settlement Penalties
Some loan contracts include early settlement penalties or exit fees. For instance, DBS’s business loan only allows changes to the agreed amount of the loan tenure if you pay a prepayment fee or an administrative fee.
Some interests are also pre-computed even if you are settling the loan ahead of the agreed loan tenure. Lenders calculate the amount of interest you’ll pay over the agreed loan tenure and add it to the principal amount due. This means that paying ahead will have no bearing on whether you save more money and you may even incur additional expenses that are unnecessary.
#3 Not Being Able To Enhance Your Credit Score
Ironically, taking your time to pay off a loan would contribute to building a healthy credit score, since it builds up a longer history of timely and responsible loan repayment. When you quickly (or immediately) repay your loans, it is considered a closed account on your credit report. This shortened payment history decreases the diversity of your credit portfolio.
While you do eventually have to close a credit account, a way of reducing its negative effect on your credit score is to ensure that you have sufficient payment history and existing open accounts.
Having sufficient loans with good payment conduct will improve your personal credit bureau and also company credit bureau. Banks are also running a business if they see your business have a long business relationship with them, and your business has good payment conduct; it will be easier for you to get another loan.
#4 Cashflow Inflexibility
When you surrender a large amount of money to pay off your principal, you are taking away from your business savings buffer. In the early stages of your business, the lack of a savings buffer may mean greater stress for your cash flow management since you face cashflow inflexibility to hire new staff or take on bigger projects if you need to.
You may require the extra buffer of cash depending on your business life stage as well. Your expenses invariably go up if you are about to get new assets for the business, and a savings buffer might be the emergency fund that you’ll need to tide you through this period of increased spending.
#5 No One-Size Fits All
Of course, pre-paying your business loan in full ahead of your loan tenure isn’t always the worst. In the case of paying using one time off, large cash inflow due to the sale of assets or having one-off revenue will be ideal. The savings could be small, but it is better off leaving in the bank earn not interest from our Corporate bank account. There is a saying, saving is earning. If you have excess cash and doesn’t have a use for it, by saving some interest and clearing off the loan, is also a form of gain.
Written by Melvin Ho, CEO & Founder of BizSquare, a one-stop business consultancy firm providing Loan Consultancy Services, Accounting and Corporate Secretarial Services, Branding and Marketing Consultancy, Strategy Management and Start-up Mentorship.
If you need more advice on business loans, you may always contact us to book an appointment for a free consultation.