Whether you are looking to finance expensive equipment or borrow money to finance your operations, a term loan can be a good option. These are commercial loans that you repay over a fixed period, for example 18 months. Some business owners prefer them because the repayment amounts stay the same each month and the interest often doesn’t fluctuate.
“Term loans encompass a wide range of loans,” Melissa Wylie, senior small business writer at LendingTree, told business.com. “There are working capital loans, inventory loans, and more general financing for business owners. Term loans can be a great place to start.”
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What is a term loan?
When you take out a term loan, you receive a lump sum of money that you must repay over a set period of time. Payments are due weekly, bi-weekly, monthly or quarterly. The interest rate you pay on a term loan is either fixed or variable. If it’s fixed, you’ll pay the same interest for the life of the loan. If it is variable, the interest may fluctuate. Mortgages, SBA loans, and auto loans are common term loans.
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How does a term loan work?
Term loans work like any other borrowing product. You apply for a term loan through a lender, who will either approve or reject your application. If you are approved, you will receive a lump sum of the initial money and the repayment terms of the loan, which include interest. It is up to you to meet the payment obligations.
Term loans can be either secure or insecure. With a secured loan, you must provide collateral. If you fail to repay the loan, the lender can come after this asset. An unsecured loan does not require collateral. They tend to have higher interest rates and are harder to obtain.
Point: There are several types of term loans, with varying interest rates and repayment requirements. You should research all of your financing options before borrowing money.
When to use a term loan?
Small businesses use term loans for many purposes, from financing the purchase of expensive equipment to covering cash shortages. Here are some of the most common uses.
- To purchase new hardware: With a term loan, you can buy expensive machinery and equipment and repay it in small installments, preserving more cash for your operations.
- To support growth: Whether you want to recruit new employees or expand new product categories, a term loan can help you grow.
- To avoid cash shortages: Cash is king. If you face the short term cash flow problemsa term loan can help you bridge the gap.
- To refinance the debt: Debt can be a drag on profits. You can use a term loan with a lower interest rate to consolidate and refinance your unsecured debt.
There are many reasons to use a term loan, but there are also times when it doesn’t make sense. Borrowing money that you can’t afford to pay back is a big deal. The same goes for making risky bets or using it for non-business expenses.
“It happens all the time: Business owners borrow money for stupid things, like having more personal cash flow or going on vacation,” said Drew Giventer, CEO of Accountable Capital. “They lose sight of the mix of their professional and personal lives.”
What are the types of term loans?
Term loans can be equipment financing, working capital or installment loans. What sets them apart is how quickly you pay them back. When choose the conditions of your professional loan, you need to weigh the cost of borrowing against the benefits. You don’t want to pay it back long after the asset or investment has gone up in value. A long-term loan makes sense if the equipment depreciates over a long period, but a 60-month term loan is not the best option for covering a short-term cash crunch.
“Longer terms mean small payments, but you could be paying much longer than you want,” Wylie said. “A short-term loan is ideal if you need a loan now to get through a slow season. It’s really about balancing how much you can pay regularly with how long you want to make the repayments.”
Here are the main types of term loans:
- Short term loan: These are unsecured loans that you repay in 12 to 18 months. Payments are usually daily or weekly. Short-term loans generally have higher interest rates than long-term loans. You can use them to cover your expenses until your cash flow recovers.
- Medium-term loans: These loans have repayment terms of one to three years, usually with monthly payments.
- Long term loans: The repayment terms of these loans can range from three to 25 years. Long-term loans are usually used for expensive equipment or goods. Borrowers must make monthly or quarterly payments until they have repaid the loan.
What are the benefits of using a term loan to finance your business?
Small business owners may prefer term loans over other types of financing for several reasons. A big one is stability. You’ll know exactly how much you owe and when it’s due. This facilitates cash flow management and forecasting. This cannot be said of other loan products.
Term loans also tend to have lower interest rates and an easier application process. You can deduct the interest on your business term loan at tax time, and it can improve your business and personal credit scores.
How do I apply for a term loan?
Before you apply for a term loan, comparator between lenders. The interest rate you will pay may vary depending on the lender, the type of term loan and your credit score. Be sure to look at the APR, or annual percentage rate, rather than the interest rate when comparison shopping. The APR tells you the total cost of the loan.
Your credit score will play an important role in the interest rate you pay and whether you will be approved. That’s why it’s important to know your business and personal credit scores before shopping for a loan, to help you narrow down your options. Review your credit reports to ensure there are no errors affecting your status with lenders.
Lenders have different underwriting criteria, but most consider your business and personal credit score, cash flow, business and personal assets, time in business, annual sales, and business plan. It is beneficial to gather all of your documents – including tax returns, tax returns and bank statements – before completing the application. This will speed up the subscription process.
When looking for a small business loan, you’ll find there are plenty of options, even if you have bad credit or a new business.
“Loan programs are everywhere,” said Matt Vannini, president and CEO of Restaurant Accounting Services. “Don’t assume you can’t qualify.”
