A term loan is a type of business financing that provides businesses with a lump sum of money to be repaid over a specific term. It’s beneficial for substantial investments, such as business expansion or large equipment purchases.
Borrowers can tailor flexible repayment schedules to their specific needs, with both short and long-term options available for a variety of business purposes. They’re offered by banks, credit unions, and non-bank lenders.
If you need a lump sum to invest in your business, a term loan is a straightforward option. Continue reading for everything you need to know about term loans, including how they work, their advantages, and the factors affecting the interest rate of term loans, among many others.
What Does a Term Loan Mean?
A term loan is a lump-sum borrowed capital repaid over a fixed term, typically used for significant, one-time expenditures. It plays a crucial role in business growth, funding capital investments, and enhancing operational capacity.
A term loan, often just referred to as a “term,” is a monetary loan that is repaid in regular payments over a set period of time or term. Typically, term loans are used to assist businesses in funding large-scale expenditures or operations that are expected to improve their future earnings.
With term loans, the borrower gets a lump sum of cash upfront, then pays the lender back over time with interest. The lender, which can be a bank, credit union, or other financial institution, sets the interest rate, loan term, and other terms and conditions based on various factors, such as the borrower’s creditworthiness and the size of the loan.
Term loans can have short, medium, or long terms. Short-term loans usually last less than a year, medium-term loans typically have terms from one to five years, and long-term loans can last for more than five years. Each type of term loan can serve different purposes, depending on a business’s needs.
The importance of term loans lies in their potential to provide a significant infusion of capital for businesses. This borrowed capital can be used to finance a variety of needs, from expanding operations and purchasing equipment to refinancing debt and providing working capital. By spreading the repayment over a longer term, these loans can provide more manageable payments for businesses, reducing the financial strain and allowing for better financial planning.
How Does a Term Loan Work?
A term loan operates through an agreement where a lender provides a borrower with a specific amount of cash, which the borrower repays with interest over a predetermined time frame.
The process of obtaining a term loan typically begins with a business identifying a need for additional funding. Once the need is identified, the business will approach a lender – which could be a bank, credit union, or online lending platform – and apply for the loan. This process can be done online or in person, depending on the lender’s setup.
As part of the application, the business will need to provide various pieces of information, including the reason for the loan, the amount needed, and financial information such as tax returns, bank statements, and financial projections. The lender will use this information, alongside a credit check, to assess the risk associated with lending to the business. If the lender deems the risk acceptable, they will approve the loan.
Once approved, the lender will offer the business a loan agreement that outlines the terms of the loan, including the amount borrowed, the interest rate, the repayment schedule, and any fees associated with the loan. The borrower must agree to these terms before receiving the funds.
Upon agreement, the lender disburses the loan amount to the borrower, who then begins making regular payments according to the agreed-upon schedule until the loan is fully paid off. It’s important to note that failure to make these payments as scheduled could result in penalties and negatively impact the business’s credit rating.
Advantages of Acquiring Term Loans
Term loan advantages for businesses include:
- Predictable Repayment Structure: With fixed interest rates and a set repayment schedule, term loans allow businesses to plan and budget for their debt repayment effectively.
- Capital for Growth: Term loans provide businesses with the capital they need to fund significant investments or expansion initiatives.
- Interest Rates: Term loans often come with lower interest rates compared to other forms of credit, making them a cost-effective borrowing option.
- Credit Building: Timely repayment of a term loan can help businesses build a positive credit history, which could be beneficial for securing future financing.
- Ownership Retention: Unlike raising capital through selling equity, term loans allow business owners to retain full control and ownership of their company.
Despite these advantages, it’s important to carefully consider the full cost and commitment of a term loan before applying. Borrowers should ensure they understand the terms and conditions of the loan and have a solid plan in place for repayment.
Requirements for Getting a Term Loan
The required documents for a business to get a term loan include:
- Completed Loan Application: Borrowers will need to complete a loan application form provided by the lender. This form typically requires details about the borrower and the purpose of the loan.
- Business Plan: Many lenders require a detailed business plan that outlines the business’s strategy for growth, future revenue projections, and how the loan funds will be used.
- Financial Statements: Lenders often request copies of financial statements, including balance sheets, income statements, and cash flow statements, for the past two to three years.
- Tax Returns: Both personal and business tax returns are usually required to provide a clearer picture of the borrower’s financial situation and ability to repay the loan.
- Bank Statements: Recent bank statements from both personal and business accounts can be required to provide further evidence of financial stability.
- Credit Report: Lenders will typically run a credit check on both the business and the owner. A good credit score can improve the chances of loan approval and potentially secure a lower interest rate.
- Legal Documents: Depending on the business structure, lenders might ask for articles of incorporation, commercial leases, franchise agreements, or other relevant legal documents.
- Proof of Collateral: For secured term loans, proof of assets that can serve as collateral may be required. This could be real estate, equipment, or other business assets.
- Owner’s Resume: Some lenders might request a resume or CV of the business owner to understand their experience and management skills.
It’s important to keep in mind that requirements can differ significantly between lenders and loan types, so it’s crucial to research and understand the specific requirements of each potential lender before applying.
Factors to Consider Before Applying for a Term Loan
Consider the following factors before applying for a term loan:
- Purpose of the Loan: Identify the specific reason for needing the loan. This could be anything from business expansion, inventory purchasing, equipment acquisition, or working capital needs.
- Loan Amount: Determine how much you need to borrow. Over-borrowing can lead to unnecessary interest payments, while under-borrowing might not fulfill your financial need.
- Repayment Capability: Evaluate your ability to repay the loan on time. Consider your income, existing debts, and potential changes in future cash flows.
- Interest Rate: Understand the interest rate you’ll be paying. Lower rates will result in lower overall loan costs.
- Term Length: The term length impacts the size of your monthly payments and the total interest paid. Shorter terms mean larger monthly payments but less total interest paid, while longer terms result in smaller monthly payments but more total interest paid.
- Loan Terms and Conditions: Thoroughly review the fine print, including fees, penalties, and other terms and conditions of the loan agreement.
- Lender Reputation: Consider the reputation and reliability of the lender. Read reviews and testimonials from previous borrowers if possible.
Factors Affecting the Interest Rate of Term Loans
Factors that can impact the interest rates of business term loans include:
- Credit Score: Borrowers with higher credit scores often secure lower interest rates as they pose a lower risk to lenders.
- Loan Amount: Larger loans often come with lower interest rates, reflecting economies of scale.
- Loan Term: Short-term loans often have higher interest rates than long-term loans.
- Type of Loan: Secured loans, which are backed by collateral, generally have lower interest rates than unsecured loans.
- Market Conditions: Prevailing economic conditions, such as the base rate set by the central bank, can affect interest rates.
- Lender’s Policy: Each lender has its own criteria and risk appetite, which can affect the interest rates they offer.
- Business Health: A stable, profitable business might be offered lower rates compared to a business with unstable income or financial instability.
Term loan interest rates can vary amongst lenders. That’s why applying with National Business Capital is a great choice for businesses. The company shops over 75 lenders to find business owners the best rates and terms on their loans. This saves business owners time and money in the application process.
Why Term Loans May be the Ideal Choice for Small Business Funding
Term loans can be an ideal choice for small business funding due to their structured repayment plan, flexibility in use, the potential for large loan amounts, and capability to build credit, all while retaining business ownership.
For small businesses seeking funding, term loans often emerge as an attractive option. They provide the borrower with a lump sum of cash up front, which can be used for various purposes like buying equipment, purchasing inventory, or funding business expansion. Since the repayment schedule is set at the outset, businesses can plan their budgets accordingly.
One of the main reasons small businesses opt for term loans is the flexibility they offer. Unlike specialized loans that must be used for a specific purpose, a term loan can be used as the business sees fit. This can be especially beneficial for small businesses with diverse needs such as renovations, inventory, and payroll.
Term loans also typically offer higher borrowing amounts than other forms of small business financing like business credit cards or lines of credit. This makes them suitable for substantial investments that have the potential to significantly boost business growth.
Moreover, by consistently making on-time payments on a term loan, small businesses have the opportunity to build their credit. A strong credit profile can improve the chances of securing further financing in the future.
Lastly, unlike raising capital through investors, a term loan allows the business owner to retain full ownership of the company. This can be a crucial factor for owners who want to maintain control of their business operations.
Frequently Asked Questions
Are there any fees associated with obtaining a term loan?
Yes, lenders often charge fees such as origination fees, late payment fees, and sometimes prepayment penalties. These should be outlined in the loan agreement.
How long does it take to get approved for a term loan?
The approval time can vary widely from lender to lender. Some online lenders may offer approval within 24 hours, while traditional banks might take several weeks to review your application and make a decision.
What are the risks of term loans?
The primary risk associated with term loans is the potential for default if the business cannot keep up with the repayment schedule. This could result in financial penalties, damage to your credit score, and, in the case of secured loans, loss of collateral.
Can I pay off a term loan early without any penalty?
This depends on the lender and the terms of your loan. Some loans come with prepayment penalties, meaning you would be charged a fee for paying off the loan before the end of its term. Be sure to read the loan agreement carefully or ask your lender about prepayment policies.
What happens if I miss a payment on my term loan?
Missing a payment on your term loan can result in late fees and negatively impact your credit score. If you anticipate difficulty making a payment, it’s usually a good idea to contact your lender ahead of time to discuss potential options.