Term loans are monetary loans that are repaid in regular payments over a set period of time. Term loans usually last between 1 and 10 years, but may last as long as 30 years in some cases. Term loans usually involve an unfixed interest rate that will add additional balance to be repaid.
Term loans are loans from a bank for a specific amount that has a specified repayment schedule and a fixed or floating interest rate. For example, many banks have term-loan programs that can offer small businesses the cash they need to operate from month to month. Often, a small business uses the cash from term loans to purchase fixed assets such as equipment for its production process.
Term loans for equipment, real estate or working capital are usually paid off between 1 and 25 years. Term loans carry a fixed or variable interest rate, monthly or quarterly repayment schedule, and set maturity date. Term loans require collateral and a rigorous approval process to reduce the risk of repayment. Term loans are appropriate for an established small business with sound financial statements and a substantial down payment to minimize payment amounts and total loan cost.
Types of Term Loans
An intermediate-term loan runs less than three years, is paid in monthly installments from a company’s cash flow and may have balloon payments. Repayment is tied to the useful life of the asset financed. A long-term loan runs for 3 to 25 years, is collateralized by a company’s assets and requires monthly or quarterly payments from profits or cash flow. The loan limits other financial commitments the company may take on, including other debts, dividends or principals’ salaries, and can require an amount of profit to be set aside for loan repayment.
One thing to consider when getting term loans is whether the interest rate is fixed or floating. A fixed interest rate means that the percentage of interest will never increase, regardless of the financial market. Low-interest periods are usually an excellent time to take out a fixed rate loan.
Floating interest rates will fluctuate with the market, which can be good or bad for you depending on what happens with the global and national economy. Since some term loans last for 10 years, betting that the rate will stay consistently low is a real risk.
Also, consider whether the term loan you are looking at uses compound interest. If it does, the amount of interest will be periodically added to the principal borrowed amount, meaning that the interest keeps getting higher the longer the term lasts. If the loan does use compound interest, check to see if there are any penalties for early repayment of the loan. If you get a windfall or profits increase spectacularly, you may be able to pay off your entire balance before it is due, preventing you from paying additional interest by waiting for the loan term to end.
Some loaning institutions offer a variety of repayment plans for term loans. Commonly, you may choose to pay off your debt in even amounts, or the amount you pay will gradually increase over the loan period. If you expect that you will be more financially able to repay in the future, causing an incremental increase may help you and save you interest. If you are unsure of your future monetary position, even payments may help prevent defaulting on the loan if things go badly.
A Small Business Administration (SBA) loan encourages long-term financing. Short-term loans and revolving credit lines are also available for assistance with a company’s short-term and cyclical working capital needs. Maturities for long-term loans vary according to ability to repay, purpose of loan and useful life of the financed asset. Maximum loan maturities are seven years for working capital, 10 years for equipment and 25 years for real estate. A loan is repaid with monthly payments of principal and interest.
A fixed-rate loan payment remains the same because the interest rate is constant; a variable-rate loan requires a different payment amount when the interest rate changes. A lender may establish an SBA loan with interest-only payments during a company’s startup or expansion phase; the business then has time to generate income before making full loan payments. Balloon payments are not allowed on most SBA loans. The SBA charges the borrower a prepayment fee only if the loan has a maturity of 15 years or more and is prepaid in the first three years. Every loan is secured by all available business and personal assets until the recovery value equals the loan amount or until all assets are pledged as reasonably available.
Choosing a term loan may be in your best interest, depending on your circumstances. Beware of extremely long repayment periods, as generally speaking, the longer the term, the more you will owe because the interest accrues over a long period of time.
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