A term loan is a type of business loan that must be paid back over an agreed period. Term loans are the best solution if you need money to finance your business but can’t afford to take it out of the business. The payment period of a term loan can last between one year, ten years or thirty years depending on the agreement between both parties.
A term loan is mostly used for a one-time expense like purchasing equipment, purchasing an asset, purchasing a landed property, or expanding your business.
Terms loans are usually provided by Banks and credit unions, and can either be secured or unsecured. A secured loan requires collateral, while an unsecured loan does not require collateral but it comes with higher interest and strict credit requirements. The best way to approach a term loan is to borrow only as much as you can pay.
Types of Term Loan
There are three types of term loans, they include; short-term loans, intermediate-term loans, and Long Term loans.
- Short-term Loan; this type of loan is obtained to support a short need. It can either be for personal use or business purposes. The payment period for short-term loans usually last from six months to two years. This is the most valuable option for small businesses because short-term loans are unsecured loans; They have a low interest rate and are easy to get.
- Intermediate Loan; The payment period for intermediate loans is usually between one and three years with a fixed amount to be paid monthly. What makes an intermediate loan good is that you can pay back from the profit of what you used it for.
For example, if you get a new icing machine and you start selling Ice, the profits you make from the sales can go into repaying the loan. This way, the loan pays for itself and once payment is made in full, you get to keep your icing machine and your profits afterwards.
- Long-term loans; The payment period for long term loans can be between three to thirty years. Long-term loans are used for large projects or getting really expensive items that bring profits like a car for Uber, a new branch of your business, etc.
There is no risk of rollovers for long-term loans because it takes so long to pay back and comes with interest rates.
Pros of a Term Loan
- Flexibility: There is no specific rule for obtaining a term loan. The terms and conditions on the agreement between the lender and the borrowers. The interest rate is also fixed after negotiation and cannot be changed.
- Complete Ownership: When using a term loan, the ownership of your business is retained. All term loans are debt financing and you have access to finance your business without forfeiting equity stake in your business.
- Varying Terms: Term loans are available in different periods of payment like short-term, long term and intermediate-term. Most lenders offer all terms of payment depending on the need and size of your business and also offer tax-deductible interest.
- Easy Access: A term loan is easily accessible and fast to obtain making it the best option during the time of emergencies. The ease that comes with obtaining a term loan than any other financing method, is the reason why so many businesses go for a term loan.
- Good Credit Score: A term loan helps establish and improve your credit scores. By making timely payments, you demonstrate your ability to manage debt responsibly and improve your credit score.
- Shareholders' Interest: In the case of a corporation or LLC, a term loan does not affect the interest of the shareholders making their interest remain undiluted.
- Effective Budgeting: Since a term loan has a fixed interest rate and a fixed repayment period, it is easy to create your budget since the payment is predictable and consistent.
Cons of a Term Loan
- Strict Process: To obtain a term loan can be very difficult for small businesses especially if they have no credit history, financial statement, or collateral to present to the bank as confidence about the organization's finances. It is also advisable to carry out a risk assessment before taking a term loan to avoid repossession and bankruptcy. Even though term loan is easily accessible than other loans, it still requires extensive documentation such as a statement of finance and business plan.
- Fixed Rates: A term loan includes an interest fee, which means you'll pay back both the borrowed money (principal fee) and the extra charge for borrowing (interest fee). Taking a term loan to buy equipment can be risky because equipment loses value over time, and you might end up owing more than the equipment is worth when you sell it.
- Strict Repayment Schedule: Every term loan is paid in installments on a specific regular payment like bi-weekly, bi-annual, or monthly. Failure to make a timely payment will increase your credit score or even rip you off the ownership of your collateral. Early payment before the fixed period will also attract a penalty.
Difference between Banks, Credit unions and Online Lenders
Term loans can be obtained from various sources, such as banks, credit unions, and online lenders. While the application processes for banks and credit unions may take longer, online lenders offer a more streamlined experience, requiring only basic information about you and your business. They can provide funding quickly with the agreed-upon payment period and interest rate, often making it available almost immediately.
While a term loan can be beneficial when needed, it is essential to thoroughly review the loan's terms and conditions before accepting it. Make sure the type of term loan aligns with your business budget to ensure a suitable fit.