Term loans for businesses are a great way for you to grow your business and achieve your goals.
Term loans are a flexible tool that can be used for just about anything, from funding a new project, to paying off debt or consolidating it into one loan, or even just as a way to boost your cash flow.
If your business is still in its infancy, you might want to consider getting a term loan to help you get up and running faster. This will allow you to focus on building your brand and creating the product or service people are going to love!
What is Term Loan
Simply put, a term loan is a loan that has a set repayment schedule and is granted for a specific amount of time. These loans are typically extended for a longer period of time, which can be anywhere between one year and ten or thirty years. These loans may have fixed or fluctuating interest rates that change in accordance with market conditions. Term loans can be acquired on an individual basis in addition to being frequently used as small company loans.
Understanding Term Loans
Small firms that require funding for equipment purchases, a new facility for their manufacturing processes, or any other fixed assets to maintain their operations frequently receive term loans for business. Some companies take out monthly loans to get the money they require to operate. Many banks have created term lending programmes to assist businesses in this way.
The same as with any other credit facility, business owners apply for term loans by contacting their lender. They must offer documents proving their creditworthiness, including statements and other financial proof. A large sum of money is given to accepted borrowers, who then have a set amount of time to pay it back, typically on a monthly or quarterly basis.
Term loans have a predetermined maturity date and a fixed or variable interest rate. The asset’s useful life may impact the repayment schedule if the proceeds are utilised to finance the purchase of an asset. To lower the risk of default or missed payments, the loan requires security and goes through a thorough approval process. As mentioned earlier, some lenders could demand down payments before approving a loan.
Term loans are popular among borrowers for a number of reasons, including:
- Easy application procedure
- Receiving a one-time payment in full
- Particular payments
- Decreased interest rates
By taking out a term loan, a business can utilise its remaining cash flow for other purposes.
Let us now understand term loans in more detail through their features, kinds of term loans as well as advantages.
Features of Term Loans
- These secured loans are term loans. The asset that is acquired with the term loan amount will act as the company’s principal security, with other assets acting as collateral security.
- No matter how financially stable the company is, the loan must be returned within the stipulated term.
- The interest rate for the loan is determined after considering the proposal’s credit risk, the loan amount, and the loan’s term. There will be a minimum lending rate that will govern the interest rate. At the moment the loan is disbursed, the rate is agreed upon between the borrower and the lender.
- The term loan has a maturity of five to ten years. The loan is repaid over time in instalments. To assist borrowers in handling their financial difficulties, the term may be postponed.
- The lender will request that the borrower refrains from seeking out new loans, pay off any existing debt, and maintain a minimal asset basis.
- In accordance with the requirements set out by the lender, term loans may be converted into equity.
- Financial institutions charge defaults a penalty.
- The commitment fee is applied to the remaining loan balance.
- After the first grace period of one to two years, the principal loan amount must be paid back.
- Financial institutions’ term loans are repaid in equal semi-annual instalments, whereas commercial banks’ term loans are repaid in equal quarterly instalments.
- The loan’s servicing burden decreases with time. The principal repayment will not change, but the interest will be lower.
Types of Term Loans
Term loans exist in a variety of forms, which often correspond to the loan’s term. These consist of:
- Short term loans: Companies who are ineligible for a line of credit are typically provided with these forms of term loans. They can also refer to a loan of up to 18 months, but they often last shorter than a year.
- Intermediate-term loans are repaid in monthly instalments from a company’s cash flow and typically last one to three years.
- Long-term loans: These loans can range in duration from three to twenty-five years. They demand payments on a monthly or quarterly basis from earnings or cash flow and put firm assets up as security. They can restrict the amount of debt, dividends, or principals’ salary the business can incur, as well as impose requirements. Long-term loans may need you to set aside profits in order to repay the loan amount.
Loans with short or intermediate terms that have balloon payments are also possible. This indicates that the last payment swells or balloons into a far higher sum than any of the earlier ones.
Now that we have learned enough about term loans to understand what they are, the types and other attributes, let us now see what makes them so alluring for people to opt for them. And then, we should also see the disadvantages of term loans.
|Advantages of Term Loans||Disadvantages of Term Loans|
|For the borrower, the loan is affordable.||The lender will question the borrower’s liquidity situation and the viability of the business if the borrower doesn’t make the repayments.|
|Because the interest paid on a term loan is tax deductible, the borrower might profit financially from the interest paid.||The financial risk to the firm is increased by debt financing. It has a negative impact on the stockholders’ gains.|
|Because term loans are negotiable, their terms and conditions are flexible.||The borrower will also need to take care of the restrictive covenants that the lenders have placed, in addition to the collateral security. The borrower must pay off all outstanding loans, keep their asset base intact, and refrain from taking on any new debt. The operation of the company is therefore unnecessarily interfered with.|
|The interest of the equity shareholder is not diminished by the term loans, which constitute debt financing.||There is a danger that the terms and conditions might conflict with the lender’s interests because they are negotiable.|
|Since the lender will have collateral, the loan does not pose a significant risk to the financial institution.||Due to the fact that the term loan lender will have little influence over the company’s operations, the lender will request that the borrower convert the loan to equity.|
|The lender will have a regular and constant revenue since the borrower will be making regular payments toward the main loan amount and interest.|
|The lender can have the authority to govern the affairs since the debt can be converted to equity.|
Why do companies take out term loans?
A term loan is typically used for property, machinery, or working capital and is repaid over a period of one to 25 years. Term loan proceeds are frequently used by small businesses to fund the purchase of fixed assets like machinery or a brand-new facility for their manufacturing operation. Some companies borrow the money they require to function month to month. To especially assist businesses in this way, several banks have launched term lending programmes.
Some Term Loans Offered in India
Here are a few lenders in India who provide term loans:
Project loans are authorised with term loans. A new unit is established or existing units are expanded using the loan. The loan sum may also be utilised to purchase building materials, equipment, and other items. The interest rate is often based on a variable rate, and it also depends on the borrower’s creditworthiness, credit rating, the risk involved, the length of the loan, and other pertinent considerations.
For long-term asset building for your company or to assist you to purchase capital goods, Union Bank of India offers term loans. You can also exchange the expensive loans you have from other banks or lenders. The loan may be obtained on a basis of a Deferred Payment Guarantee. The longest period is 84 months. Additionally, the loan is available in international currencies.
Term loans are provided to cover the capital costs associated with modernising the project, adding new units, and expanding existing ones.
Businesses can obtain term loans with a 5-year term for business expansion, capital expenditures, and fixed assets. To suit the borrower’s particular demands, a short-term financing option is also offered. The payments are coordinated with the borrower’s financial flow.
Working capital example
Long-term funding is encouraged by a Small Business Administration (SBA) loan, sometimes referred to as a 7(a) guaranteed loan. A company’s immediate and cyclical working capital needs can also be met with the aid of short-term loans and revolving credit lines.
Long-term loans have different maturities depending on the borrower’s capacity to repay, the loan’s intended use, and the asset being funded. The maximum maturity periods for real estate loans are typically 25 years, up to 10 years for working capital loans, and 10 years for the majority of other loans. The borrower makes regular principle and interest payments to repay the debt.
An SBA fixed-rate loan has the same monthly payment as any other loan since the interest rate is fixed. A variable-rate loan, on the other hand, has changeable payments because the interest rate changes. In the early stages of a company’s development or expansion, a lender may set up an SBA loan with interest-only payments. As a result, the company has some time to make money before completing all of the loan instalments. The majority of SBA loans forbid balloon payments.
If the loan has a duration of 15 years or more, the SBA merely assesses a prepayment fee to the borrower. Every loan is secured by business and personal assets up to the point where the recovery value equals the loan balance or the borrower has committed all reasonably accessible assets.