Term Loan: Definition and All You Need To Know 2023

As a business owner, you understand the need to invest in new growth prospects. However, you may not always have the funds to make these investments. Small company funding can be a lifeline in this situation. If you’re looking for a loan, you’ve probably considered a term loan.

However, before agreeing to a term loan, it is critical to understand what it is and how it differs from other available options.

What Exactly Is a Term Loan?

A term loan is a company loan that must be repaid over a specified time period. The loan must be repaid at a fixed or adjustable interest rate. Term loans are typically only available to established enterprises, and they may need a considerable down payment in order to lower payment amounts and loan costs.

Term loans are typically used to purchase fixed assets such as land, buildings, or machinery, as well as for long-term expenditures such as corporate development or modernization. They are also occasionally used for project finance.

How Do Term Loans Work?

A term loan is obtained from a bank, credit union, or internet lender. Banks and credit unions typically give the best rates, but they have more severe standards and might be more difficult to qualify for.

In comparison, while an online lender may charge higher interest rates, the application procedure is simpler, and you will often obtain faster approval and cash. If you apply through a lending marketplace, you will only need to submit one application and will receive offers from numerous lenders.

You must agree to the rates and repayment terms once you’ve chosen a business lender and been authorized for the loan. Rates are determined by a variety of factors, including your personal and business credit history, cash flow, and time in business.

A company loan’s payback durations typically span from three to ten years. If you acquire a fixed-rate loan, your interest rate will remain constant during the term of the loan. Your interest rate will fluctuate on a variable-interest loan.

The Main Features of a Term Loan

There are numerous qualities and services that term loans accomplish or have the ability to perform. Among these features are:

Term loans are received from banks and financial institutions and typically last five to 10 years, however, they can last longer.
They are secured loans, which means that assets backed by term loans serve as security, while other assets serve as collateral security.
They are required. Once established, term loans incur interest and principal repayments that must be made whether the borrower makes a profit or not.
Term loans feature a fixed interest rate that is agreed upon by the borrower and lender at the time the loan is established.
Term loans are subject to particular restrictions. Lenders may force enterprises to maintain a minimum asset base and refrain from making new loans or repaying current ones over the term of the loan.
Term loans can be converted into equity based on the terms and circumstances imposed by the lending institution.

Types of Term Loans

If you opt for a term loan, you can apply for one that is short-term, intermediate-term, or long-term.

#1. Short-term loans

These are loans for lesser amounts with shorter repayment periods – usually one or two years.

Short-term loans are ideal for covering day-to-day working capital costs. However, because these loans are more accessible and quicker to obtain, you can expect to pay higher interest rates.

#2. Intermediate-term loans

Intermediate-term loans fall somewhere between short- and long-term loans. Repayment durations are normally two to five years, with a maximum loan amount of $500,000.

These loans are a wonderful alternative for firms wishing to expand or start a new location. This form of finance might assist you in expanding your business operations and starting to generate more revenue.

#3. Long-term loans

Long-term loans have the greatest loan amounts as well as the longest repayment terms. You can obtain finance in the millions of dollars, with repayment terms of up to 25 years.

A long-term loan is a fantastic alternative for a well-established company with good credit and a stable financial history. You may use one to fund long-term growth strategies for your company.

Example of a Term Loan

A 7(a) guaranteed loan from the Small Business Administration (SBA) encourages long-term funding. Short-term loans and revolving credit lines are also available to assist a company’s cyclical and immediate working capital needs.

Long-term loan maturities vary depending on the borrower’s ability to repay, the purpose of the loan, and the useful life of the funded asset. Maximum maturity dates for real estate are typically 25 years, up to 10 years for working capital, and 10 years for most other loans. The borrower makes monthly principal and interest payments to repay the debt.

An SBA fixed-rate loan payment is the same as any other loan payment because the interest rate is fixed. In contrast, the payment amount for a variable-rate loan might change when the interest rate changes. During a company’s starting or expansion period, a lender may establish an SBA loan with interest-only payments. As a result, the company has more time to create revenue before paying complete loan payments. The majority of SBA loans do not permit balloon payments.

The SBA imposes a prepayment fee to the borrower only if the loan has a maturity of 15 years or more. Every loan is secured by business and personal assets until the recovery value matches the loan amount or the borrower has pledged all reasonably available assets.

How to Apply for a Term Loan

The following are the actions you must take when applying for a term loan:

#1. Get your paperwork in order

Before applying for a loan, you should organize your financial information. The specific requirements differ by lender, but here’s a summary of what you should anticipate to provide:

Employer identification number (EIN)
Personal and business credit history
Business tax returns
Bank statements
Profit and loss statement
Income statement

#2. Apply with multiple lenders

When applying for a term loan, keep the overall cost of the loan in mind at all times. If the interest rates are very high and you do not create a lot of extra cash from your investment, you may find yourself in debt. Applying with numerous lenders allows you to compare interest rates and payback conditions to discover the most inexpensive loan for your business.

Many lenders will pre-approve you for a loan with simply a mild credit check, so you don’t have to worry about your credit score being harmed. You can also use a loan marketplace to apply and obtain various offers with just one application.

#3. Evaluate your options

Once you’ve received offers from numerous lenders, weigh them all. It may be tempting to choose the lender with the greatest loan amount, but there are a few additional factors to consider.

Keep an eye out for the annual percentage rate (APR), which will tell you how much it will cost you to borrow the money. You should also consider the repayment conditions, as they will have a substantial impact on your capacity to repay the loan.

It is also critical to pay special attention to any costs charged by the lender. It’s easy to overlook fees if the loan has a low-interest rate and flexible repayment periods, but they can add thousands of dollars to the cost over the life of the loan. Here are some significant fees to be aware of:

Origination fees: These are the fees you will pay the lender upfront to process the loan. These costs range between 1% and 5% of the loan amount.
Prepayment penalty: Because the lender loses out on future interest payments if you pay off the loan early, some lenders charge a penalty fee.
Late fee: As with other monthly fees, you will be charged a late fee if you make your monthly payment late.

A processing fee is charged to cover the expense of underwriting the loan.

#4. Complete the loan

You’re ready to close on the loan and receive the funds once you’ve picked a lender and agreed to the terms. You may receive the monies within a day or two of the closing, depending on the lender.

What Are the Advantages and Disadvantages of Term Loans?

Term loans, like all lending solutions, offer advantages and disadvantages that must be considered before making a decision.

Pros

They can meet short-term finance requirements. A term loan can be a fantastic alternative if you need to buy new assets or equipment for your business. You can use the chance to expand your activities, and the revenue you generate will help you repay the debt.
They typically have lower rates. Term loans often have low-interest rates and flexible repayment terms. You can return the loan over time without it becoming an undue financial burden on your company.
They assist you in establishing business credit. A term loan can be a terrific strategy to develop your small business credit if you make your monthly payments on schedule.

Cons

They are relatively difficult to obtain. Term loans are typically more difficult to qualify for than other types of loans due to their advantageous interest rates and repayment durations. You must have an outstanding credit history and present your lender with accurate financial details.
Some lenders will insist on collateral. If your lender views your company as a financial risk, they may want you to put up collateral. This is referred to as a secured loan, and if you are unable to repay it, your personal or business assets would be at danger.
They may levy additional charges. For term loans, some lenders charge additional fees, such as origination fees. Depending on the lender, you may even be charged a prepayment penalty if you pay off the loan early.

When Should You Consider a Term Loan?

If you’re looking for startup funding, you have a lot of possibilities. So, how can you determine if a term loan is better for your company than, say, a revolving line of credit?

A term loan is a fantastic option for a short-term project or expense. A term loan, for example, can assist you to cover the cost of purchasing merchandise or investing in a marketing campaign.

Term loans are best suited for well-established enterprises with a track record of financial success. If you have bad credit or no company experience, getting a term loan may be tough.

Finally, term loans are ideal for organizations that do not want funds right away. Applying for a term loan can be time-consuming, especially if you want to take advantage of the low-interest rates offered by a bank or credit union. So, if you need cash quickly, a term loan may not be the greatest solution.

How Long is the Duration of the Long-term Loan?

Long-term loans have a period of more than three years. The length of a long-term loan might range from 3 to 30 years. Before loan acceptance, the borrower and lender agree on a time frame. A long-term loan is typically a big sum that must be repaid over a long period of time.

Who is Eligible for a Term Loan?

A good credit score is required to obtain a term loan because it determines the borrower’s creditworthiness. A good credit score also helps borrowers achieve a lower interest rate and a longer term. Before approving your loan, a lender must confirm that you have a solid financial record in order to avoid any delays in repayment or a default.

How Do You Repay a Term Loan?

A term loan is paid back in predetermined monthly instalments, or EMIs. Every month, the EMIs are deducted from the borrower’s account on a certain date. If the borrower has extra funds, they can pay the difference over and above the EMI. This is known as partial prepayment, and it is an excellent strategy to lessen your future payment burden.

What is a Term Out Loan?

Term out is the accounting practice of converting short-term debt to long-term debt without incurring new debt. The ability of a firm or lending institution to “term out” a loan is an important debt management approach that occurs in two scenarios.

Is Term Loan Good or Bad?

When utilized responsibly and for the correct reasons, term loans may be a valuable financial instrument. They provide borrowers with a lump sum payment upfront, allowing them to satisfy their financial objectives and aspirations. Furthermore, Term Loans frequently have cheaper interest rates than other types of borrowing, such as credit cards.

Is Term Loan Same as Overdraft?

An overdraft loan is a feature that allows a customer to withdraw funds from a current account even if the balance is zero, but only up to a specified amount.A term loan is a loan in which a fixed quantity of money is borrowed for a set length of time. This money must be repaid with interest.

Conclusion

Term loans have numerous advantages, such as when a firm needs working cash to purchase equipment or supplies to expand its operations. The expenses are also reasonable, as assets such as property must be utilized to secure the loan. However, this comes at a cost because the company must expose itself to the risk of repossession.

The ideal way to approach a term loan is to borrow only what you can really afford to repay.

Term Loan: Definition and All You Need To Know 2023

Table of Contents Hide

What Exactly Is a Term Loan?

How Do Term Loans Work?

The Main Features of a Term Loan