Worked Examples and Checklists
Refinancing an expensive business loan in Canada: penalties, break-even and a worked example
When refinancing a high-rate Canadian business loan pays off, how to price the prepayment penalty and new fees, the break-even arithmetic, and the trap of stretching the term.
Refinancing a business loan pays off when the interest you save over the remaining period is larger than the prepayment penalty plus the new lender's fees, and when you keep the new loan's term no longer than what is left on the old one. Work out three numbers: the monthly saving, the months it takes to recover the costs, and the total cost of each option to the same end date. A lower payment achieved by stretching the term can cost more overall.
This guide is part of the business loan application checklist. Figures are illustrative.
When refinancing is worth looking at
- The loan was taken when the business was young, unprofitable or short of security, and results have improved since.
- It came from an online lender or alternative provider at a high rate.
- You have several small, expensive debts that one secured loan could replace.
- Rates in general have fallen since a fixed rate was set.
- You need to remove a restrictive covenant or a lender that will not support growth.
The worked example
An Ontario HVAC contractor took a $250,000 loan three years ago at 11.5%, when it had one year of results. It now has four profitable years.
| Current loan | Refinance offer | |
|---|---|---|
| Balance today | $180,000 | $180,000 |
| Rate | 11.5% | 8.25% |
| Remaining period | 4 years | 4 years |
| Monthly payment | about $4,696 | about $4,415 |
| Interest to payoff | about $45,409 | about $31,943 |
Costs of switching
- Prepayment penalty in the current agreement: three months' interest = $180,000 x 11.5% / 4 = $5,175.
- New lender's fees, legal costs and PPSA registration: $2,100.
- Total costs: $7,275.
The arithmetic
- Monthly saving: $4,696 − $4,415 = about $281.
- Break-even: $7,275 / $281 = about 26 months.
- Total cost to the same end date: staying = $45,409 of interest; refinancing = $31,943 + $7,275 = $39,218.
- Net saving: about $6,190 over 4 years.
You can reproduce this in the refinancing calculator.
The term-stretching trap
The new lender offers to spread the $180,000 over 6 years instead, for a payment of about $3,178 a month. That is $1,518 a month less than today, which looks attractive.
- Interest over 6 years: about $48,816.
- Plus costs: $48,816 + $7,275 = $56,091.
- Compared with staying ($45,409): about $10,680 more.
A longer term can still be the right decision if the business needs cash now, for example to fund growth or survive a slow season. But it is a cash flow decision, not a saving, and you should compare it with a separate line of credit for the cash need.
Financing the costs
If the contractor adds the $7,275 to the new loan, it borrows $187,275 at 8.25% over 4 years. The payment is about $4,594 and interest about $33,234. Total cost to payoff: $33,234 of interest plus the $7,275 of costs repaid through the loan = $40,509, still about $4,900 less than staying. Paying the costs in cash saves an extra $1,290 or so.
How prepayment penalties are calculated
Read the prepayment clause of your current agreement. Common forms on Canadian business loans:
| Method | How it works | Typical on |
|---|---|---|
| Open | No penalty | Most floating-rate loans and lines |
| Months of interest | For example three months' interest on the amount prepaid | Fixed-rate term loans |
| Interest rate differential (IRD) | Difference between your rate and the lender's current rate for the remaining term, on the amount prepaid | Fixed-rate loans and commercial mortgages |
| Percentage of balance | For example 3% in year 1, 2% in year 2, 1% in year 3 | Some alternative lenders |
| Yield maintenance | Compensates the lender for all lost interest | Larger commercial mortgages |
The Interest Act's section 10 right to repay a mortgage after five years with three months' interest applies only to mortgages on real property and does not apply to a mortgage given by a joint stock company or other corporation, so corporate borrowers, and all loans not secured by a mortgage, fall outside it. Your contract governs.
A refinancing checklist
- Get the payout statement from your current lender in writing, with the penalty.
- Ask the new lender for a commitment letter listing all fees.
- Keep the same end date in your comparison.
- Check the new covenants, security and guarantees: a cheaper loan with an unlimited guarantee may not be a better deal.
- Ask whether the new lender will register its security first; the old lender must discharge its PPSA or RDPRM registration after payout.
- Confirm there is no gap in your operating line during the switch.
Before you apply, run the debt service coverage ratio on the new payment, and compare competing refinance offers with comparing two loan offers.
Frequently asked questions
Will my current lender match the new rate?
Sometimes. A written offer from another lender is the best negotiating tool. Ask whether it will reprice without a penalty.
Can I refinance a merchant cash advance?
Often yes, by paying the remaining purchased amount from a new loan. Ask the provider for the exact payoff figure and whether any discount applies for early payoff. See merchant cash advances.
Does consolidating several loans help my DSCR?
It can, if the new loan has a lower rate or longer amortization. The lender will look at the total payment after consolidation.
Is the penalty tax-deductible?
A penalty to repay business debt is generally deductible, but the timing and method depend on the facts. Ask your accountant.
Sources
- Justice Laws Website — Interest Act, including section 10
- BDC — refinancing and consolidation of business debt
- Bank of Canada — policy rate decisions that move floating rates and lenders' prime
- Canada Revenue Agency — deductibility of financing costs
