A Term Loan is a loan given to established small businesses to purchase equipment, acquire real estate, or boost its working capital. Just like mortgage, term loans are repaid within a specified period of time, which is between one year and 25 years. Additionally, a term loan normally has a floating or fixed interest rate for the fixed repayment period. However, in order for a business to obtain a term loan, it has to put down collateral and undergo a demanding approval procedure so as to lower the risk of paying off.
Therefore, term loans are beneficial for small businesses as banks are able to create programs that will supply them with the cash needed to perform daily operations on a monthly basis. There are some online lenders who offer term loans to small businesses without necessarily requesting for collateral though it really depends on the loan amount.
Online lending companies just require a person to sign as a guarantor to assure repayment. This is because the companies see term loans as a personal loan to the business owner. Nonetheless, business owners have to have excellent credit scores in order to be considered for the loan. Even so, the online companies offer the repayment schedule of term loans for a period of one to five years.
Categories of Term Loans
Term loans can be categorized into two types – intermediate term loans and long term loans.
Intermediate term loan
This type of loan is a short-term loan as it lapses in less than three years. The intermediate loan is repaid in monthly installments from the business’ cash flow. Since the intermediate term loan uses the business assets as collateral so the repayment of the loan will be directly tied to the practicality of the asset that is being financed. Generally, an intermediate term loan can be ideal for businesses seeking to refinance debt, open a second branch, hire new employees, or purchasing equipment.
Long term loan
This type of loan lapses from three to 25 years. The collateral used for this type of loan is the business’ assets and the repayment mode is normally based on monthly or quarterly profits or cash flow. The long term loans restrict the business from handling other financial commitments such as paying up debts, business owner’s salaries, or dividends. Moreover, long term loans sometimes require certain amount of proceeds to be put aside for the loan repayment.
Characteristics that lenders look at when assessing Term Loan applicants
The several features that banks look at when deciding whether or not to approve the term loan application include business’ capital, credit score, collateral involved, credit capacity, and the viability of the business plan.
- Business’ capital: this means that the business has to have assets that can be swiftly converted into cash when the need arises. Here, the business has to have assets that will provide avenue for the borrower to repay the loan on time.
Credit capacity: this indicates that the business or its owner has to have a credit score that can allow him to access term loans.
- Collateral: this is the business’ major source of settlement. Thus your lender evaluates the asset attached to the loan and it has to be larger than the loan amount.
- The assurance of the business plan: In this case, your lender evaluates the income and expenditure projections of the business plan.
How to obtain a Term Loan
Just like any business loan, a term loan application requires the business and/or owner to present different pieces of specific information relating to the business. For instance, your lender may require you to submit your record of invoices and other sales records.
In order to increase the chances of approval, you need to have a fully filled out loan request form and also be willing to provide any extra information required by lender. Moreover, you will require a well-written and thorough business plan that will explain the reason for the need of funding for the business. The financial statements for the business and its proprietors for the previous three years are equally vital if you want the loan to be approved.
Your lender will also require the tax returns of the business for the past three years. Furthermore, the bank will require a debt plan together with financial projections of the business for the next three years. Your lender will also require information on the assets that are intended to be purchased by the business. This includes sales agreements, contracts among others.
Advantages and Disadvantages of Term Loans
Advantages of Term Loans
- A business or individual is able to plan for settling the loan because the repayments are foreseeable with the fixed interest rates.
- Term loans are affordable for businesses because the loan is paid over a long period of time compared to other short-term loans.
- Term loans tend to be easier to repay for businesses because they have a lower interest rate compared to other small business loans.
Disadvantages of Term Loans
- Term loans have fixed repayment schedules, hence making it less flexible for businesses as compared to other business loans.
- Term loans tend to be harder for small businesses to obtain because not only are the loan requirements numerous, the loan application review is strict too.
How is a Term Loan used?
A term loan can be used by businesses to upgrade or expand. For example, a business can obtain a term loan for key capital enhancement, huge capital investments such as working capital, equipment, purchasing property as investment, and buying existing businesses.