Merchant cash advances have become a popular way for small business owners to get financing. However, due to the high costs and daily payment schedule, MCA recipients may quickly find that their advance is placing a major strain on their business finances. One potential solution to that problem is to refinance a merchant cash advance.
The Problem With Merchant Cash Advances
Every MCA works a bit differently, including the length of the repayment period, the payment structure, and the costs. In general, however, MCAs share a few common characteristics.
For one, they come with short repayment terms — usually no longer than two years. They also require that payments be deducted daily (or sometimes, weekly). And the costs can be steep; MCA providers charge a factor rate that’s typically between 1.1 and 1.5.
Business owners that take on merchant cash advances tend to run into a couple of problems. First, the sheer cost of the advance can put a strain on their finances. For example, a $100,000 advance with a factor rate of 1.3 would cost $30,000 in fees.
Unfortunately, some MCA recipients try to solve their cash flow issues by getting another MCA. This is referred to as “stacking.” It can result in a cycle of debt where the business owner is never able to pay off the advances, and end up digging themselves deeper into debt.
What Is Refinancing?
Refinancing involves replacing an existing credit agreement with a new one (typically, a loan). The goal is to make favorable changes to the agreement, such as a lower interest rate, longer or shorter repayment period, or other terms outlined in the contract.
This is similar to debt consolidation, which is when you combine several debts into one, often with more favorable terms.
Can You Refinance a Merchant Cash Advance?
The short answer: yes. But it’s important to go about it the right way. Let’s take a look at your options for refinancing an MCA and which is best.
Refinancing Options: MCA vs. Loan
One of the biggest mistakes you can make is refinancing a merchant cash advance with another one. That’s true even if the payments are lower.
Why? Merchant cash advances don’t work like traditional business loans (in fact, they aren’t loans at all). And unlike business loans, cash advances don’t amortize.
Here’s what that means: When you make payments on a typical loan, interest and principal are tracked separately through a process called amortization. When you pay off your principal early, you actually save money by paying less interest overall.
With a merchant cash advance, on the other hand, the principal and interest (AKA your factor rate) are lumped together and split up equally across payments. For example, say you take out an advance of $100,000 with a factor rate of 1.3. The total cost of your MCA is $130,000, and you must pay that full amount to close the account. There are no savings for paying it off early.
Using another MCA to pay off your current one not only means taking on another expensive, non-amortized debt. A chunk of the new MCA will go toward paying off the interest on your original one, which means you end up paying interest on interest.
A better way to refinance a merchant cash advance is by replacing it with a term loan. A traditional bank loan typically has much lower interest rates, a fixed monthly payment, and a repayment term of around three to five years. The catch is that there are more stringent eligibility requirements. You’ll have to show that you’ve been in business for a while, you have good credit, and are cash flow positive. The lender will likely require you to provide tax returns, bank statements, profit and loss statements, and more to prove you can afford the loan.
Should I Refinance a Merchant Cash Advance?
You understand that you can refinance or modify a merchant cash advance. The important question now is should you ?
In general, you can probably benefit from refinancing an MCA if the payments are currently causing a cash flow crunch, you can qualify for a loan with better terms, and the cost of refinancing doesn’t outweigh the savings.
It also helps to weigh the pros and cons when deciding whether to refinance an MCA or pursue other financing options that make sense for your business:
Pros:
- Monthly installments: An MCA requires that payments be deducted daily or weekly from your business bank account. This can strain cash flow and make it difficult to meet your daily business obligations. With a business loan you only need to make one payment per month.
- Fixed payments: MCA payments fluctuate depending on your revenue. If you bring in a lot of money one day, your payment could increase. And if you don’t make as much another day, your payment is smaller. With a bank loan, your payment is the same amount every month, so you know what to expect and can budget accordingly.
- Longer repayment period: You don’t get much time to pay back a merchant cash advance. Typically, it’s only 4-24 months. On the other hand, a traditional installment loan comes with a longer term of around 2-5 years.
Cons:
- Closing costs: Even though taking out an installment loan is much cheaper than an MCA, you still need to pay closing costs. This is cash that needs to be paid upfront, or rolled into the loan.
- Requires a credit check: To qualify for a loan from a traditional lender, you generally need to have good credit. The application process will include a credit check of both your business credit and your personal credit. This means your credit can temporarily drop by a few points.
- May need collateral: Depending on the health of your credit and overall finances, the lender may also require you to put up collateral (such as inventory, real estate, etc.) in order to qualify for a traditional business loan. If you fail to repay the loan according to the terms, the lender can seize these assets (and potentially start litigation against you and your business).
Get Help With MCA Debt
A merchant cash advance can turn into a major burden for your business. If you’re struggling with MCA debt payments, it’s important to review your rights and legal options. Failing to repay an MCA according to the terms can be considered a breach of contract, and MCA funders may pursue legal action. That can include filing a lawsuit. Plus, they may harass you and your clients, as well as file a UCC lien against your business income.
Tayne Law Group has been helping clients find solutions to their consumer and business debt — including merchant cash advances — for more than 20 years. We offer a free, no-obligation phone consultation with an experienced business attorney who can offer you solutions to your business debt challenges. Call today and learn about how we may be able to help. Your call is never outsourced to a third-party call center, and your information is never shared or sold. Call today at 866-890-7337 or fill out our short contact form. All conversations are confidential.
