For many new and small business owners, loans seem like a necessary evil. Taking on debt to get access to capital to purchase equipment, commercial property, and more can be a big burden to carry. Yet when businesses try to get out from under their debts by paying off loans early, they suddenly find themselves hit with prepayment penalties. So how do prepayment penalties work and is there a way to avoid them without staying in debt?
How Prepayment Penalties Work
Prepayment penalties are typically baked into traditional business loans and set as a percentage of the total remaining balance. For example, let’s say a business is paying off a loan and has reduced the balance to $10,000. During a very lucrative month, the business has amassed enough capital to take care of overhead costs and pay off the remaining balance in one fell swoop.
This seems like a fiscally responsible move that will allow the business to zero out their debt and improve their credit ratings. But if the prepayment penalties are set at 30 percent, the balance owed becomes $13,000 plus any additional interest and fees that might be attached. In a way, traditional loans penalize businesses for doing the right thing.
Should You Pay Off a Loan Early?
There are times when it makes sense to pay off a loan early despite prepayment penalties. The first situation is if the principle plus the fees are lower than the remaining total monthly installments plus interest. The short-term total outweighs the long-term loss and can allow your business to improve cash flow and revenue retention overall. The second situation is if paying off the balance will allow your business to grow at a faster rate without being held back by debt. The short-term cost of paying off the remaining balance allows businesses to retain more revenue instead of making those monthly installments to a lender, and that money can be reinvested in growth projects. Additionally, the lack of debt can help businesses rebuild their credit ratings in case they need larger financing further down the road.
Funding Your Business without Prepayment Penalties
While traditional loans have prepayment penalties, there are business financing solutions that do not. A merchant cash advance, for instance, has a more flexible payment schedule than traditional loans and no prepayment penalties. As the name implies, a merchant cash advance is working capital provided to a business without any collateral required. The advance is discretionary, meaning the capital can be used for anything the business needs.
A merchant cash advance is then repaid electronically from a small percentage of credit card sales, so businesses have the flexibility they need without suffering a strain on cash flow during uneven revenue cycles. Additionally, if a business is in a position to pay off the balance owed on a merchant cash advance, they can do so without triggering any prepayment penalties or additional fees.
Avoid Prepayment Penalties
At Web Finance Direct, we do not believe businesses should be penalized for trying to be successful or for eliminating debt. We provide finance solutions, whether your business needs working capital, equipment, commercial property, or something more specialized. Contact Web Finance Direct today to learn more about our business funding solutions and avoid the trap of prepayment penalties.