Understanding a Term Loan

Are you searching for a way to finance your business but don’t know where exactly to start looking? One of the most popular options is a term loan. But what is a term loan? And does it really fit your needs?  

A term loan by definition is a type of loan that is used by businesses in order to help in their growth and development. It provides them with an influx of capital they need to launch their operations, make investments, or get through tough times.   

This loan is secured through a bank for a specific amount and also has a specified repayment schedule with either a fixed or variable interest rate. The loan term is usually between one and ten years, so it can be classified as either a short-term loan or a long-term loan.   

The repayment schedule includes payments made monthly or quarterly, with the principal and interest payments due at each period. Some term loans may have balloon payments, which are larger payments that are due at the end of the loan term.  

The amount you can borrow is typically based on your ability to repay the loan. This means that if you have strong personal finances and good credit, you may be able to borrow more than someone with weaker finances and bad credit.  

And lastly, when you take out a term loan, you will typically need to put up collateral to secure it especially if you are trying to get a short-term loan with bad credit. Common types of collateral include property, vehicles, and savings accounts.  

What Exactly Is a Term Loan?

The term loan is a type of financing typically used by businesses to get much-needed capital in order to grow. These funds can be used for a variety of purposes, such as working capital, equipment purchases, or business expansion.   

Term loans are generally available from banks and other financial institutions, and they may be secured or unsecured.  

The interest rate is usually fixed, meaning that it will not fluctuate over the life of the loan although in some cases it may be variable.  

Fixed rate makes budgeting for repayment easy and predictable and the borrower will also typically be required to make monthly payments, which can help to further reduce financial stress.  

How Do Term Loans Work?

One of the benefits of a term loan is that it can be obtained quickly and easily, often with little documentation required. This makes them ideal for businesses that need access to cash quickly.  

You apply for a term loan through a bank, credit union, or online lender. Banks and credit unions tend to offer the most favorable rates, but they have more stringent requirements and can be harder to qualify for.  

In comparison, an online lender may have higher rates, but the application process is more straightforward, and you’ll often receive faster approval and funding.   

To qualify for a term loan, businesses will typically need to have been in operation for at least six months and have a good credit history. They will also need to provide collateral, such as equipment or real estate, to secure the loan.  

Once you’ve chosen a business lender and been approved for the loan, you must agree to the rates and repayment terms. The rates you’ll receive depend on various factors, including your personal and business credit history, cash flow, and time in business.

Pros and Cons of Term Loans

There are a few things to consider before taking out a term loan, as they’re not right for everyone. Here, we will discuss some pros and cons to help you decide if this loan is the right financing option for your business. Be sure to weigh out all of these factors carefully before committing to anything.  

One big advantage of these loans is that they are typically more affordable than other types of loans, such as lines of credit or credit cards. Additionally, you can get a large amount of money in one lump sum. This can be helpful if you need to make a major purchase or invest in your business.  

One of the biggest disadvantages is that it can be really hard to qualify for these loans especially if your business is new or you don’t have that good of credit.  

Pros  

• You can borrow a large amount of money this way.  
• The interest rate is typically fixed, so you know what your monthly payments will be.  
• You have a set repayment schedule, so you can plan ahead and budget accordingly. 
• Repayment terms are usually 5 years or less, so it’s a shorter commitment than other types of loans. 
• There is great flexibility in how you use the money.  

Cons  

• The interest rate on a term loan is often higher than on some other types of loans, such as SBA loans.  
• You may be required to provide collateral, such as business assets or real estate, to secure the loan.  
• If you miss payments or default on the loan, your collateral could be seized by the lender. 
• There may be additional fees. Some lenders charge additional costs for term loans, such as origination fees.  

Types of Term Loans

There are several types of term loans available to businesses. The most common are traditional bank loans, SBA term loans, and equipment financing.  

Traditional bank loans are the most basic type of term loan. They are typically for businesses with good credit scores and a strong history of financial stability. The interest rate on a traditional bank loan is usually lower than on other types of loans.  

SBA loans are backed by the Small Business Administration and sometimes have more relaxed eligibility requirements than traditional bank loans. They can as well be used for a variety of purposes, including start-up costs, working capital, and expansion.  

Equipment financing is a type of term loan that is used to purchase equipment for your business. The equipment serves as collateral for the loan, so it is important to choose wisely and only finance equipment that is essential to your business.   

Term Loan vs. Loan Period: What’s the Difference?

The terms “term loan” and “loan period” are often used interchangeably, but there is a key difference between the two. A term loan is a specific type of loan that usually has a fixed interest rate and a set repayment schedule. The loan period, on the other hand, is the length of time that you have to repay the loan.  

This simple distinction is really important as it shows how different the meanings behind both words are. Be sure you are completely familiar with these and many other terms associated with any loan type as it will greatly help you understand what you are signing up for. 

Bottom Line

A term loan is a loan that is repaid over a set period of time, typically one to five years but it can be longer as well. The money can be used for a variety of purposes, including working capital, equipment purchases, or expansion. Additionally, the interest rate on a term loan is typically fixed, and the repayment schedule is usually amortizing, meaning that each payment includes both principal and interest.  

If you’re considering taking out a term loan, it’s important to understand the basics before you apply. Here, we briefly covered everything you need to know about them, from how they work to what you’ll need in order to qualify.