Making curtailments (or prepayments) on a loan can reduce the amount of money you owe in interest, shorten the amount of time you have a debt, and help free up cash flow once the loan is paid off. When it comes to small business loans, making curtailment payments can also create more opportunities for business growth, help you get additional financing, and attract a higher sale amount from buyers if you’re looking for an exit.
Before you make curtailments, read your loan agreement. It is not uncommon for a lender to add prepayment or curtailment penalties, fines, or fees into the loan agreement. When borrowers make curtailments, it reduces the amount of money the lender makes. By adding a prepayment clause, the lender can protect their revenue.
Pro-tip: Curtailment clauses could be called balloon payment penalties, step-down fees, or declining percentages. They can also be time-based if you make too many payments and lower the premium too fast. Ask your lender about any jargon you don’t understand, as it could be a curtailment fee.
The Benefits of Curtailments on Business Loans
If you’re in the clear to make curtailments without a penalty, or the fees are less than the gains, here are some of the benefits of making curtailments.
- Save on interest payments.
- Business credit scores can rebound faster.
- Companies are more appealing to potential buyers.
- You can have more cash flow on hand.
Save on Interest Payments
The main benefit of making curtailment payments on a business loan is the reduced amount of money you spend on interest payments over the life of the loan. This applies when your interest payments are based on the principal (the total amount owed) instead of a flat fee.
If you have a current fixed rate loan for $300,000 and a 12% interest rate, and you make monthly payments, your interest payment is $3,000.
(principal*interest rate)/12 = monthly interest payment
($300,000*.12)/12 = $3,000
If you prepaid $15,000 as a curtailment before the first monthly payment, you would pay interest on $285,000 instead of $300,000, reducing your monthly interest fee to $2,850.
($285,000*.12)/12 = $2,850
In this example, you’d save around $2,000 in the first year.
Faster Business Credit Score Recovery
Business credit bureaus track your business’s current debts, sometimes including the principal on a business loan. Clearing the debts they track can help you increase your business credit score more quickly. By making curtailments on the business loan, you can begin to pay the debt faster by reducing the principal, thus clearing it from the business credit bureaus’ reports sooner. Once the debt is no longer owed and recorded, your business credit score will begin to rise.
Less Debt Makes Acquiring Your Company More Attractive
If you’re looking to exit your company, potential buyers may be turned off by outstanding debts. Other times, they’ll make a lower offer to buy you out because there are additional costs to acquiring your business.
By making curtailment payments before you begin looking for a buyer, you reduce the debts your company owes. As buyers begin inquiring, you are in a better position to ask for a larger amount of money.
Freeing Up More Regular Cash Flow
Making curtailments clears your debt to the lender faster, and now you have the money you would have made in payments back in your business bank account. This money can be used to finance payroll, increase inventory, give yourself a bonus, or increase your savings for unexpected emergencies or future growth.
You may also be eligible to recast your business loan by doing a large curtailment. Recasting a loan is something you can do when you have a history of making payments on time and your lender is willing to reduce the principal amount that is recorded if you agree to pay a large lump sum. This lowers your monthly payments, and if the principal is recorded by the business credit bureaus, it reduces the amount of debt your business has, helping to increase your business credit score as an added benefit.
The main benefit of curtailments is that they can reduce the amount you have to spend on interest for a personal or business loan. They can be used as part of a strategy to clear the total debt off your credit report faster so that you can work on increasing your credit score. Depending on your situation, with less debt, you may be able to sell your business for a higher price if you’re looking for an exit or qualify for a larger business loan if you plan on expanding or growing soon.
