What Is a Term Loan?
A term loan gives borrowers an enormous sum of money upfront for agreed-upon loan terms. Term loans are often reserved for well-established small firms with solid financial records. The borrower agrees to a specific repayment schedule with a fixed or fluctuating interest rate for a specific amount of money. To minimize the payment amounts and the total cost of the loan, term loans may require large down deposits.
Understanding Term Loans
Small firms that require capital to purchase equipment, a new building for their manufacturing processes, or any other fixed assets to keep their businesses running frequently receive term loans. On a month-to-month basis, several firms borrow the funds they require to function. Many banks have created term loan programs designed expressly to assist businesses in this way.
Term loans are applied for in the same way that any other credit facility is applied for: by approaching a lender. They must present financial statements and other proof of their creditworthiness. Borrowers who are approved receive a lump sum of money and must make payments over a set length of time, usually monthly or quarterly.
Term loans have a predetermined maturity date and a fixed or variable interest rate. If the funds are used to purchase an asset, the asset’s useful life may impact the repayment plan. To limit the risk of default or failure to make payments, the loan requires security and a rigorous approval process. Some lenders may need a down payment before approving a loan.
Term loans are popular among borrowers for a variety of reasons, including:
- Simple application process
- Receiving an upfront lump sum of cash
- Specified payments
- Lower interest rates
Taking out a term loan also frees up funds in a company’s cash flow that can be put to better use.
Types of Term Loans
Term loans come in a variety of shapes and sizes, with the term usually indicating the length of the loan. These are some of them:
Short-term loans: Term loans are typically granted to businesses that do not qualify for a line of credit. They usually last shorter than a year, however, they can also refer to an 18-month loan.
Intermediate-term loans: These loans are typically one to three years long and are paid back in monthly installments from a company’s cash flow.
Long-term loans: These loans might run anywhere from three to twenty-five years. They require monthly or quarterly payments from profits or cash flow and use corporate assets as collateral. They limit the company’s other financial commitments, such as other loans, dividends, or principals’ salaries. They can require a portion of profit to be set aside, especially for loan repayment.
Short-term and intermediate-term loans can both be balloon loans with balloon payments. This signifies that the final installment expands or balloons to a significantly bigger sum than the others.
Example of a Term Loan
Long-term funding is encouraged with a Small Business Administration (SBA) loan, often known as a 7(a) guaranteed loan. Short-term loans and revolving credit lines can also be used to meet a company’s immediate and cyclical working capital requirements.
Long-term loan maturities vary depending on the borrower’s ability to repay, the loan’s purpose, and the useful life of the funded asset. Real estate loans have maximum maturity dates of 25 years, working capital loans up to ten years, and most other loans have maximum maturity dates of ten years. The loan is repaid in monthly principal and interest instalments by the borrower.
The payment on an SBA fixed-rate loan is the same as any other loan because the interest rate is fixed. In contrast, because the interest rate fluctuates, the payment amount on a variable-rate loan can change. During the start-up or expansion period of a business, a lender may establish an SBA loan with interest-only payments. As a result, the company has more time to create revenue before having to pay back the entire loan. Balloon payments are not permitted on most SBA loans.
Only if the loan has a maturity of 15 years or more does the SBA charge a prepayment fee to the borrower. 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.
Why Do Businesses Get Term Loans?
A term loan is typically used for equipment, real estate, or working capital and is repayable over a period of one to 25 years. A small business will frequently use the funds from a term loan to purchase fixed assets for its production processes, such as equipment or a new building. Some companies take out monthly loans to cover their operating costs. Many banks have created term-loan programs designed expressly to assist businesses in this way.
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