What is a Term Loan?
A term loan is an upfront payment of cash which is paid off over a certain time period. Term loans can last from one to thirty years, though they are most commonly between one and ten. As term loans are often medium to long term options, they usually offer lower interest rates than other types of loan with shorter repayment periods. Term loans are usually secured by collateral and rates can vary from 6-30% depending on the credit history of the applicant. They can be approved within 48 hours in some instances. This type of financing is sometimes called project financing.
Term loans are generally for amounts ranging between $20,000 to $500,000. It can be paid back at various intervals, such as once a week, twice a month, once a month, quarterly, or whatever is agreed by the borrower and lender. It is often once a month or every 3 months. Payments are the same throughout the length of the loan. Term loans can have fixed or floating interest rate repayments, as well as compound interest. The rate is most often fixed. Longer repayment dates have the advantage of flexible financing, but the total amount payed back including interest will be greater.
Who Should Apply for a Term Loan?
Term loans are ideal for businesses who need to purchase an expensive asset. It might be an upfront cost, but the asset could be essential to the running of a business, such as a high-quality kitchen for a restaurant. Term loans are an easy way for businesses to gain access to finance while still keeping their balance flow healthy. Any business that needs access to finance for a large upfront expense should consider a term loan. It can also be used for less tangible upfront costs, such as websites, employee training or paying off other debts. A term loan is one of the most common forms of debt raised by small businesses, often referred to as term finance.
Default and Liability
Failure to repay a term loan is not a criminal offense. It is a matter of the civil courts. Only when the loan is used for purposes other than what is stipulated in the contract will the resulting action be deemed a criminal one. A debt default generally results in civil proceedings where the borrower will lose the collateral and business. For borrowers who sign a letter of guarantee, personal belongings may also be lost. If the debt is not secured by collateral (most term loans are) then the lender can sue for bankruptcy, so the company assets are used to repay the debt. In the event of bankruptcy, debtholders are paid first.
Pros and Cons of Term Loans
- Term loans can be obtained in as little as 24 hours in some cases.
- Debt financing lenders have no ownership in the borrowing company.
- The maturity of the debt can generally be altered.
- Long terms up to 30 years are available.
- Interest on debt is tax deductible.
- Collateral nearly always required.
- Failure to pay fixed interest can lead to bankruptcy.
- If inflation remains low for prolonged intervals, real cost of repayment can be more than expected for fixed rates.