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What Is a Term Loan?

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Last editedMar 20222 min read

A term loan is a business loan which must be paid back over a set period of time. Businesses must repay the loan at a fixed or floating interest rate. Term loans are usually only available to established businesses and they may require a company to put up a significant down payment in order to reduce payment amounts and cost of the loan.

Term loans are generally used to purchase fixed assets like land, buildings or machinery, or for long term investments such as business expansion or modernisation, and they’re also sometimes used for project financing.

Main features of a term loan

  • Term loans are obtained from banks and financial institutions and often run over periods of five to ten years, although they can run into the longer term.

  • They are secured loans, so assets financed through term loans act as security, while other assets serve as collateral security.

  • They’re obligatory. Once set up term loans incur interest and repayments of the principal that have to be paid whether a borrower is earning a profit or not.

  • Term loans have a fixed interest rate that’s negotiated by the borrower and lender at the time of setting up the loan.

  • Term loans carry certain restrictions. Lenders can ask companies to maintain a minimum asset base and require that they don’t raise additional loans or pay off existing ones during the course of the loan.

  • Term loans can be transferred into equity depending on the terms and conditions laid down by the financial institution offering the loan.

Benefits of term loans for borrowers

  • Companies can borrow money at relatively low cost.

  • The interest payable on a term loan is tax deductible.

  • Term loans are negotiable between borrower and lender, so the terms and conditions are flexible.

  • Term loans represent debt financing, so shareholders’ interests remain undiluted.

Benefits of term loans for lenders

  • Term loans are secured against assets by banks and financial institutions, so they’re a safe way of lending.

  • Borrowers are obliged to pay interest and capital repayments whatever their financial position giving the lender guaranteed income.

  • Banks can ask borrowers to convert term loans into equity which can give them control over the company’s affairs.

Disadvantages of term loans

Equipment depreciates over time, and if the loan is taken out for a longer period, the equipment could depreciate more rapidly. As such, you may risk owing more than the equipment is worth when you sell it. Obtaining a term loan is not always easy for a new business, since new businesses may not have sufficient financial statements to provide banks with confidence about the organisation’s finances. It’s essential to carry out a risk assessment before taking out a term loan to avoid the risk of repossession and bankruptcy.

Use a long term calculator to work out repayments

The main feature of a term loan is that it’s fixed for a set period of time. Because of this, you can schedule the instalments of the loan beforehand. A long term loan calculator can help you compute the initial value of a term loan, so using a loan repayment calculator can help you work out how much different loans from different lenders would cost.

You simply enter the details of the loan you’re considering into the monthly repayment calculator, and it will work out how much you’ll have to pay on a monthly basis and how much you’ll be paying back overall.

Term loans have many advantages, for example when a company requires working capital to buy equipment or supplies to expand a business. The costs are reasonable too, since assets including property have to be used to secure the loan. However, this comes at a cost, since a business has to expose itself to the risk of repossession.

The best way to approach a term loan is to borrow only as much as you can afford, realistically, to pay back.

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