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A term loan provides a borrower with financing on a fixed repayment schedule. In other words, you borrow money from a lender and pay it back at set intervals over a defined period of time. This type of loan is frequently used in personal lending, like mortgages or student loans. But businesses also use term loans to help with their financing needs, whether it’s for an expansion or to solve short-term cash flow issues. Recommended: Mistake-Proof Your Business Idea
Term Loan Definition: What Is a Term Loan?
When you’re learning to define term loans, the first thing to grasp is that a term loan is a borrowed lump sum that is paid back at regular intervals over a set period of time. The interest rates for term loans can be fixed or variable, depending on the loan agreement with the lender.Term loans may also be called installment loans because they differ from revolving credit like a credit card or line of credit. Revolving credit doesn’t provide an upfront lump sum or a set payoff date. Instead, the borrower can withdraw money (up to the credit limit) at will and make a minimum payment while interest continues to accrue. As payments are made, the borrower’s available credit increases and they can then borrow more against their credit limit. By way of contrast, a term loan offers a single lump sum at the beginning of the loan term. No matter how much of the loan the borrower has paid back, there’s generally no way to borrow more without applying to refinance or get a new loan altogether.
How Term Loans Work
Term loans are common for both individuals and businesses. In your personal life, you may have term loans such as a mortgage, an auto loan, or a student loan. In each case, you borrowed a set amount of money to pay for a purchase. Then you made or still make regular payments on the loan to pay down your balance over a specific period of time, like 30 years for a mortgage, or five years for a car.Businesses may also use term loans to achieve specific objectives. Different lenders often have their own eligibility requirements, such as annual revenue and time in business minimums. Personal and business credit scores may also be factored in, as well as the company’s business plan and expected use of the funds. Some types of business term loans also require a down payment. This lowers the risk for the lender because the amount of the loan is lower and it shows the lender that the owner or owners are committed to the business.
3 Types of Term Loans
Small business loan terms are categorized based on how long the repayment period lasts: short-term, intermediate-term, or long-term. These are the three types of term loans:
1. Short-Term Loans
Short-term business loans typically last 12 months or less. Applying for a small business loan with a short term is usually a faster process than applying for a longer- term loan, and qualification standards are often easier as well. However, it’s important to compare loan rates since they can be higher when the term is shorter. Other features to look at with the different types of small business loans include origination fees, late payment fees, and early payoff penalties. Common uses for short-term business loans include working capital, inventory purchases, cash flow management, marketing, expansions, and emergency expenses. Loan amounts often range from $5,000 to $300,000.One unique feature of about many short-term loans is that payments are due more frequently than for loans with longer terms. Businesses must usually make payments weekly or even daily.
2. Intermediate-Term Loans
This type of term loan is repaid over three years or less. Unlike short-term loans, intermediate-term loans generally require monthly payments instead of daily or weekly ones. You may also qualify for a larger loan amount, assuming that your credit and capital are strong enough. In fact, some lenders may even offer loans up to $1 million.
3. Long-Term Loans
Long-term business loans can last as long as 25 years and are intended for large-scale purchases or investments. This could include buying commercial real estate, renovating a building, financing equipment, consolidating debt, or acquiring another business.While a long-term loan can have more competitive rates than other types of financing like lines of credit or merchant cash advances, rates are usually higher than you’d find with a short-term loan. Loan amounts can go as high as $5 million for Small Business Administration (SBA) loans, and potentially even more with private term loans if your business qualifies. In order to qualify, expect to need an established business history (typically two years or longer), strong credit, and stable financials. Payments are usually made monthly. Expect to offer some type of collateral, which could be equipment, real estate, or inventory. Some types of loans (like SBA loans) require a down payment of between 10% and 25%.
What Type of Term Loan Is Right for Your Business?
When grappling with what is a term loan, you soon figure out that the best type of term loan for your business depends on your financial needs as well as your company’s history and performance.Reviewing pros and cons for each type of term loan may help you decide what’s right for you.
Short-term Loans
Pros
Quick funding time
Easier qualification process
Debt is paid off faster
Cons
High-frequency payment schedule
Interest rates may be high for lower-credit borrowers
Smaller loan limits
Intermediate-term Loans
Pros
Larger loan amounts
Repayment period not drawn out too long
Payments usually made on a monthly basis
Cons
Business must be established
More in-depth approval process compared to short-term loan
Be sure to assess your business goals and lenders’ eligibility requirements as you choose the best option for your company.
Compare Small Business Term Loans
Comparing the lenders’ terms helps you improve your chances of qualifying for a loan and saves you time by helping you avoid applying for options for which you’re not eligible. On top of that, you want to make sure you’re not overpaying when it comes to rates and fees, or endangering your business cash flow with a repayment schedule that’s too aggressive.
Look at Each Lender’s Eligibility Requirements
It’s helpful to examine these requirements side by side:
Personal and business credit
Time in business
Annual revenue
Collateral
Down payment
Personal guarantee
Scrutinize the Lender’s Fees
Also look at the fees side by side:
Interest rate and APR
Origination fees
Late payment fees
Early payoff penalty
Be Sure You Understand Repayment Schedule
Questions to ask:
Are payments made daily, weekly, monthly, or quarterly?
Are payments automatically deducted from a business bank account?
Many lenders have strict repayment terms, meaning you need to make sure you can meet those standards so you don’t overdraft your accounts, accrue late fees, and damage your credit score.
Business Loan Rates
Getting a term loan can scale business growth much more quickly than simply reinvesting profits. It’s wise to create a clear plan of how you plan to use the funds and make sure the business can comfortably handle the payments, even in a downturn. It also helps to understand the types of loans your business likely qualifies for. This saves you time so you don’t end up submitting multiple in-depth applications with only a small chance of approval.One easy solution for this problem is to submit a single application through Lantern by SoFi to see offers from our lender network.
Frequently Asked Questions
What does "term loan" mean in business loans?
What is an example of a term loan?
What are the three main types of term loans?
Photo credit: iStock/Rob Daly
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About the Author
Lauren Ward
Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
