Term Loan

What is term loan?

A term loan is a loan from a bank for a specific amount that has a specified repayment schedule and either a fixed or floating interest rate. A term loan is often appropriate for an established small business with sound financial statements. Also, a term loan may require a substantial down payment to reduce the payment amounts and the total cost of the loan.

How Term Loan Works?

In corporate borrowing, a term loan is usually for equipment, real estate, or working capital paid off between one and 25 years. Often, a small business uses the cash from a term loan to purchase fixed assets, such as equipment or a new building for its production process. Some businesses borrow the cash they need to operate from month to month. Many banks have established term-loan programs specifically to help companies in this way.

The term loan carries a fixed or variable interest rate—based on a benchmark rate like the U.S. prime rate or the London InterBank Offered Rate (LIBOR)—a monthly or quarterly repayment schedule, and a set maturity date. If the loan proceeds are used to finance the purchase of an asset, the useful life of that asset can impact the repayment schedule. The loan requires collateral and a rigorous approval process to reduce the risk of default or failure to make payments. However, term loans generally carry no penalties if they are paid off ahead of schedule.

Points to remember:

A term loan is a loan issued by a bank for a fixed amount and fixed repayment schedule with either a fixed or floating interest rate.
Companies often use a term loan’s proceeds to purchase fixed assets, such as equipment or a new building for its production process.
Term loans can be long-term facilities with fixed payments, while short and intermediate-term loans might require balloon payments.

Types of Term Loans

Term loans come in several varieties, usually reflecting the lifespan of the loan.

A short-term loan, usually offered to firms that don’t qualify for a line of credit, generally runs less than a year, though it can also refer to a loan of up to 18 months or so.
An intermediate-term loan generally runs more than one—but less than three—years and is paid in monthly installments from a company’s cash flow.
A long-term loan runs for three to 25 years, uses company assets as collateral, 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 set aside for loan repayment.