Many companies will have fixed rate loans in place that currently have a fixed repayment schedule and are expensive to repay because of the associated break cost of doing so.
Companies who need a boost to cash flow should look to discuss their options with their relationship bank as there may be good reason to capitalise any break costs through raising a new loan and rescheduling the capital repayment profile.
Existing Loan Parameters:
Current Balance £1,400,000
Current Interest Period 30-Apr-20
Interest Periods Monthly
Loan Maturity 31-Aug-22
Capital Repayment £50,000 p.m.
Fixed Loan Rate 1.5% + Loan Margin
The loan break cost is calculated by discounting all the cash flows to maturity against the current market rate.
Current Market Rate 0.23%.
On a simple calculation basis, the client will pay 1.27% (1.5% Fixed Rate – 0.23% Market Rate) for the next 28 months on the decreasing loan balance of £1.4m
Loan Break Cost £21,461
The company asked their bank to restructure this loan over a longer period of time with the following conditions:
- Capitalise Break Cost of existing loan
- New loan term of 5 years
- A 1 year Capital Repayment holiday
- A new Fixed Rate for 5 years
New Loan Parameters:
Initial Balance £1,421,461
Start Date 30-Apr-20
Interest Periods Monthly
Loan Maturity 30-Apr-25
Capital Repayment Start 30-Apr-21
Capital Repayment £29,614 p.m.
Fixed Rate Loan Rate 0.35% + Loan Margin
- For the next 12 months the company would pay interest only at a reduced rate of 0.35% + Loan Margin.
- On resumption of the capital repayments the monthly commitments would reduce to £29,614 + Interest at 0.35% + Loan Margin
How much extra does this cost the company in additional interest over the new loan period?
In order to answer this question, we need to set the loan margin.
In this example we will set the loan margin at the same level for the existing and new loan e.g. Loan Margin = 2.00%
Over a 60 month period the cost of refinancing equates to c.£1,000 p.m. However, the company benefits from an increase to cash flow in year 1 of c.£600k and in year 2 of c.£233k. These savings to cash flow may be very important in allowing the company to move forward as they move from Lockdown into the new normal and readjust for the impact they have faced from the economic shock caused by the pandemic.
The actual cost to break the loan is not material in that the additional burden is simply the interest paid on the break cost amount of £21,460 over the new loan period. This equates to £1,536 on the above example and is including in the total interest figure on the new loan of £101,714
Therefore, breaking a loan with a large interest break cost may not be have the same impact that one would imagine and this is typically because the current market is in a historically low interest rate environment.
Typical interest rate difference between current and previous 5 year Fixed Rates
* Please note: All Interest Rates, Discount Rates and Calculations are indicative and for illustrative purposes only.
Whether or not you have Fixed or Floating borrowing or have hedged your interest cost through Fixed Rate loans or Interest Rate Swaps, the principle of refinancing by extending term and/or delaying capital repayments may be equally valid for any borrower.
Increasing your current borrowings
At the same time as restructuring your current debt you may wish to borrow additional money for working capital as the business comes out of Lockdown and looks to rebuild in the months ahead.
There are government schemes available to help small businesses through these difficult economic times and by looking at your holistic debt position it may make sense to combine a restructure of your existing borrowing with the requirement for additional debt.
By combining this approach, the company could look to save money on total arrangement fees and perhaps the need to increase debt to a higher level in the event the existing loan was left in place.
Bell Rock Financial Limited is an Independent Consultancy specialising in Financial Risk Management.
Email: firstname.lastname@example.org Tel: 0203 983 2300