A term loan provides borrowers with a lump sum of cash upfront in exchange for specific borrowing terms. Designed typically for established small businesses with sound financial statements, term loans deliver financial flexibility with fixed or floating interest rates and a set repayment schedule. Term loans may also require substantial down payments to mitigate total costs and payment amounts.
Key Takeaways
- Term loans provide borrowers a lump sum of upfront cash in exchange for specific borrowing terms.
- Borrowers adhere to a fixed repayment amount over a scheduled period with either a fixed or variable interest rate.
- Term loans are often used by small businesses to acquire fixed assets, like equipment or new buildings.
- Borrowers favor term loans for their flexibility and lower interest rates.
- Short and intermediate-term loans might feature balloon payments, whereas long-term loans come with fixed payments.
In-Depth Look at Term Loans
Term loans are a financial lifeline for small businesses requiring lump-sum cash to purchase equipment or fixed assets vital for day-to-day operations. Typically, the process parallels that of other credit facilities, with businesses providing financial statements to establish their creditworthiness. Successful applicants receive a lump sum, repayable based on the asset’s useful life impacts.
These loans come with enforced collateral and careful vetting processes to decrease default risks. Businesses could need to make down payments before funds are advanced.
Reasons business owners prefer term loans:
- Simple application process
- Receiving an upfront lump sum of cash
- Specific repayment schedules
- Lower interest rates
Additionally, term loans liberate company’s cash flows, allowing funds to be deployed elsewhere in business activities.
Types of Term Loans
Term loans come in varying lengths and types, typically relating to the loan’s duration. These include:
- Short-term loans: Targeted at firms lacking qualification for a line of credit, these loans typically run under a year or up to 18 months.
- Intermediate-term loans: These extend from one to three years and are often repaid monthly from a company’s cash flow.
- Long-term loans: Spanning three to 25 years, they leverage company assets as collateral and need regular payments from generated profits or cash flow, sometimes imposing limits on other financial commitments.
Both short and intermediate-term loans may involve balloon payments, making the final installment larger compared to previous ones. Most term loans follow a specific payment schedule throughout the loan period.
Real-world Example of a Term Loan
Consider the Small Business Administration (SBA) loan, such as the 7(a) guaranteed loan, designed to promote long-term financing. Including options for working capital short-term loans, these programs cater to diverse business needs.
Loan maturities depend on repayment ability, loan purposes, and the financed asset’s useful life. Maturities tend toward 25 years for real estate and ten years for working capital or other loans, invariably repaid through steady payments.
Different rates apply: fixed-rate SBA loans maintain consistent payments, variable-rate ones fluctuate. Some SBA loans permit interest-only periods during initial expansion or startup phases, allowing revenue generation before full repayment commences. Typically, balloon payments are not permitted.
SBA loans carry prepayment fees for extensive maturities over 15 years, ultimately securing personal and business assets by the borrower to cover loan amounts.
Why Businesses Opt for Term Loans
Businesses favor term loans for equipment, real estate, or working capital finance, spreading payments from one up to 25 years. They support firms in acquiring necessary fixed assets which significantly aid production processes.
Moreover, many banks provide tailored term loan programs aiding companies needing month-to-month capital fortification.
Common Characteristics of Term Loans
Term loans feature fixed or variable interest rates alongside specific repayment schedules. The asset’s useful life financed by the loan may influence the repayment plan. Critically, these loans need collateral and a stringent approval method to curtail default risk, often carrying no penalty for early repayment.
Related Terms: fixed assets, collateral, variable interest rate.
References
- U.S. Small Business Administration. “7(a) Loans”.
- SallieMae. “Fixed and Variable Interest Rates for Private Education Loans”, Page 3.
- Corporate Finance Institute. “Short Term Loan”.
- U.S. Small Business Administration. “Types of 7(a) Loans”.
- U.S. Small Business Administration. “Terms, Conditions, and Eligibility”.
