What is a Term Loan?
Updated July 2018
Term Loan Definition
Many small businesses and large businesses use financing as a way to more quickly grow or get to the next level in their industry. This is a great strategy as long as you do your numbers and ensure the interest rate of the loan does not exceed what your potential asset will be able to produce for you, immediately and in the long term.
Term loans are a basic type of commercial or business loan, ranging from:
Intermediate-Term Loan
Less than three years, often with monthly or quarterly repayment installments. Payment usually must be from the business cash flow or profits.
- Sometimes with balloon payments (repayment of outstanding loan principal, made at the end of the loan period after only paying interest throughout loan period)
- Repayment may be tied to the life of the asset if that is what is being financed
Long-Term Loan
Longer than three years, and can range from 10 to 20 years. Repayment must also often be from cash flow, and the lender might require a certain amount of profits to be set aside for repayment. These will have more requirements like:
- Collateral (something of equal value given or promised by loan taker to the loan provider, to ensure full repayment).
- Limits on the amount of other financial commitments the business can take on during the loan period.
Each type will have a fixed number of equal payments over the term of the loan, with a set maturity date. Business loan interest rates can be fixed or floating/variable (one that moves with the general market).
These types of loans are often taken out for use as working capital (money used in the day-to-day operations of a business), and as a business investment to buy assets that will produce income, like:
- Machinery
- Construction
- Equipment
- Inventory
- Hiring employees
- Marketing
Ideally, the asset that is purchased with the loan will then be able to repay the loan on its own.
Term business loans are often a great choice for financing a small business that is well established. Those that have a sound financial record and are able to make a good down payment will be rewarded with small monthly payments and fewer total costs.
The downside to term loans is the need for collateral, as well as a meticulous approval process. Lenders look very carefully at how you previously handled other loans, the business credit, personal finances if necessary, collateral available, assets that could be quickly liquidated, and how the deal looks as far as whether it’s really a good profit maker or will cause a loss. But again if your company has a decent financial track record you’ll be good to go.
