What Is a Term Loan?

 Typically granted to established small businesses in a solid financial standing, term loans involve receiving a specified single upfront payment repayable over an agreed term, which can be months or years. The lender, a bank, credit union, or online one, provides the cash, and the borrower repays it according to a specified schedule, most often in monthly or quarterly installments. The interest rate can be fixed or variable. Businesses may also have to pay a substantial down payment to lower the installments and the loan’s total cost.

Term loans afford multiple benefits, including having relatively low rates and enabling business owners to cover short-term financing needs and build business credit. Comparable to other financing options, term loans’ interest rates are low. Further, borrowers have the flexibility to repay them with the specified installments within the agreed term, which significantly lessens the financial burden on their business.

With term loans, companies with insufficient cash flow can invest in new opportunities, expand their operations, and increase their revenue. The additional revenue, in turn, can help them repay the loan. And the timely paying off of the loan installments can boost companies’ credit.

Applying for a term loan resembles applying for any other loan. Business owners approach their preferred lender and provide the required documentation, usually financial statements, to prove their creditworthiness. It is noteworthy that while the interest rates offered by banks and credit unions are typically more favorable, their qualifying criteria are more rigorous. Conversely, online lenders have more simplified and faster application and approval processes, but their rates may be much higher.

Depending on their lifespan, term loans come in three main types: short-term, intermediate-term, and long-term. Short-term loans are for smaller amounts, and typically the repayment period does not exceed one year, but some may run up to a year and a half. This type is suitable for financing daily short-term financial obligations, but its convenience and easier application process translates into higher rates. Also, short-term loans may be balloon loans and involve balloon payments, meaning the last installment is significantly larger than the earlier ones.

Intermediate-term loans’ lifespan is between two to five years. Businesses repay them monthly using money from their cash flow. Generally, providing funding amounts up to half a million dollars, intermediate-term loans can be particularly helpful with expanding business operations to generate higher revenue. For example, businesses can use them to finance opening a new location or increasing the number of their employees. Similar to their short-term counterparts, intermediate-term loans can be balloon loans.

Finally, long-term loans are a good choice for financing long-term growth strategies. They allow companies to obtain funding amounting to millions of dollars, with repayment periods of up to 25 years. However, this type of loan requires using their assets as collateral and involves paying monthly or quarterly installments from cash flow or profits.

It can also restrict companies’ other financial endeavors, such as meeting other debts, distributing dividends, or paying principals’ salaries. Furthermore, they may have to reserve a certain amount of their profits solely for repaying the loan. Thus, long-term loans are typically available to well-established businesses with proven financial records and perfect credit scores.