Should You Refinance Your Childcare Center Now?

If Your Childcare Center Currently Have A SBA 7(a) Loan:

  • If your SBA loan is a variable interest rate loan with the Prime Rate plus 2.25% to 2.75% (the highest and almost the highest interest rate allowed by law), it is very likely that you could save substantial interest expenses over the life of your loan by refinancing. If your SBA loan is a variable interest rate loan of the Prime Rate plus 1.75% to 2.24%, you will likely save money by refinancing (even after considering the lender’s closing fees); but, even more important, it protects you from future Prime Interest Rate increases.
  • Interest rates have increased 2.25% since December 2016 and interest rates are expected to continue to increase into 2019.
  • The economy is doing well and the childcare center industry is doing well, so now is the time to refinance. (When the economy and childcare industry are not doing well, it is much harder to refinance a loan.)
  • The best options are to refinance into a conventional commercial loan, or, if your childcare center is in an eligible area, an USDA Business & Industry loan.

If You Currently Have A Conventional Commercial Loan:

  • If your loan for your childcare center is currently a conventional commercial loan at an average or low rate, you will likely wait to refinance until your loan reaches maturity or is called. If your loan has a high interest rate (6.75% or above), you could save thousands each month by refinancing now instead of waiting until maturity. Refinancing could also allow you to secure a much larger amount than your current loan balance to give you “cash out” for growth capital.
  • You may want to refinance into another conventional loan, SBA 7(a) or SBA 504 loan, or an USDA Business & Industry loan. It all depends on getting the lowest interest rate, and how long the interest rate is fixed, the monthly payments, and your expectations of when interest rates will increase in the future, your desire to eliminate “calls” or balloon payments, and how long you expect to own your childcare center.
  • As of December 20, 2018, the Prime Rate is 5.50%. The Prime Rate remained low since the recession. Prior to the recession starting in 2008, the Prime Rate averaged 6.8% from 1997 to 2008. If Prime Rates return to historical levels (see Prime Interest Rates since 1990), it will make sense to refinance to a fixed rate.

Recession Proof Your Childcare Business:

  • During the Recession, many childcare centers closed because they did not have a cash reserve to sustain their business while their revenues dropped and their high overhead continued virtually unchanged.
  • During the Recession, many childcare centers closed because they had short-term conventional bank financing that had a call or balloon payment of only three to five years. During the Recession, there were many childcare centers who had to refinance because their loans had a balloon payment due, but, no lenders were willing for refinance during the middle of a credit crunch… therefore, they closed.
  • During the five years immediately previous to the Recession, the Prime Interest rate increased from 4.0% to 8.25%. This substantially increased the overhead expenses of many childcare centers who had variable interest rate loans as their monthly bank loan payments increased with the rise in the prime rate. For Each $1 million of loan amount, this would have increased a center’s monthly overhead by about $3,000. Just think of how many additional children your childcare centers would have to enroll just to pay the additional monthly $3,000 bank loan payment!

Ways to recession proof your business: 1) Converting a variable interest rate to a fixed interest rate, 2) Lowering your monthly debt service payment, 3) Not ever getting a loan that only has a 5 year (or less) balloon payment (For conventional loans, we recommend a 10 year term). By refinancing, if we can reduce your monthly loan payments by $1,000 to $2,500 per month (or more), just think of how many fewer children your childcare centers would need to have enrolled and still be making a profit!

Our next suggestion to recession proof your business is take what you save by lowering your monthly debt service payment, and to build a cash reserve in a retirement plan. For example, if your debt service payments are reduced by $30,000 per year ($2,500 per month), make an additional $30,000 pretax contribution to your retirement plan. This $30k pretax contribution will likely reduce your federal income taxes by $7,200 to $9,600 (2018 tax rates) plus additional savings from not paying state income taxes. If in the future, there is a recession and you are loosing money, you could take the $30,000 out of the retirement plan, pay a 10% penalty ($3,000), and still be ahead by a minimum of 4,200 ($7,200 – $3,000). If you don’t have to take the $30k out of your retirement plan until your retirement, then in essence, in this example, the refinancing would allow you to save up to $41,400 ($30,000 + $9,600 federal tax (36%) + $1,800 state tax (I am using a 6% state tax rate)) per year!

How long will it take to breakeven considering the lending closing fees?

It depends on your current interest rate, the interest rate that a lender will provide, and the expected increase in interest rates over the coming year(s). Call us to discuss your particular situation. 770-410-7582

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