What is Term Loan?

by Garima Sharma
Term loan

DEFINITION of ‘Term Loan’

It is a loan from a bank for a specified amount that has a specific repayment schedule with a  fixed or floating interest rate. For example, many banks have term-loan programs that offer small businesses the cash they need to operate from month to month. Often, a small business uses the cash from a term loan to purchase fixed assets like equipment for its production process.

A term loan could be availed for:

  • Equipment,
  • Real estate or
  • Working capital that could be paid off between a one to 25-year period span.

The loan has a:

  • Fixed or variable interest rate,
  • Monthly or quarterly repayment schedule and
  • A set maturity date.

The loan needs collateral and needs to undergo a rigorous approval process to reduce the risks of repayment defaults. A term loan is appropriate for an established small business that has sound financial statements and a substantial down payment in order to minimize payment amounts and the total loan cost.

Examples of Loan Types

An intermediate-term loan runs for a period of fewer than three years and is paid in monthly installments from a company’s cash flow and may have balloon payments. The useful life of the asset financed plays a significant role in the repayment schedule.

A long-term loan runs for a period ranging from three to 25 years at max, uses company assets as collateral and needs monthly or quarterly payments from the company’s profits or cash flow. The loan limits other financial commitments the company may take on, including:

  • Other debts,
  • Dividends or
  • Principals’ salaries and
  • Asking for an amount of profit to be set aside for loan repayment.

A Small Business Administration loan motivates long-term financing. Short-term loans and revolving credit lines are also available to help a company with it’s short-term and cyclical working capital needs. Maturities for long-term loans may vary with the:

  • Business’s ability to repay,
  • Purpose of loan and
  • The useful life of the financed asset.

Maximum loan maturities for real estate are 25 years, 7 years for the working capital and 10 years for most other loans. The borrower repays the loan with the monthly principal and interest payments.

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