Term Loans

What is a term loan?

A term loan is also known as a traditional or a basic commercial bank loan. These loans have historically been the best and easiest way for a small business to gain extra funding. However, banks are somewhat moving away from these traditional loans, due to the state of the economy. They may only allow options that are, in some ways, less risky for them and often more so for you. The amount of the loan also needs to be taken into account, as do the specific circumstances of your small business. A term loan lasts a fixed amount of time. The payment schedule is fixed, and the term of the loan can range anywhere from one to twenty years. The interest rate may be either fixed or floating. With shorter term loans it tends to be fixed. Because of this, the business owner knows exactly what each payment was.

What kind of small business funding comes from term loans?

Term loans are most often used to finance large initial purchases such as computer equipment or vehicles. They may also be used to provide working capital funding until a business is pulling in enough gross income to be self-sustaining.

What is a short-term loan?

A short-term loan generally lasts a year or less. These loans are also called lines of credit or working capital loans when talking about financing small business. They are intended to help the business get through the difficult first year or two before receipts increase to the point where a profit is being made. This kind of loan is, thus, most commonly taken out by new businesses. Generally, interest rates on these loans are fixed. In some cases, shorter term loans, including some that may run up to three years, may be based on the life of the specific purchase being financed by the load. The repayment schedule may be quarterly, but is more commonly monthly.

What is a long-term loan?

A long-term loan generally runs from one to seven years, but it can be as long as ten or even twenty years. Very long-term loans are seldom offered to businesses unless the purchase of real estate is involved. These are generally used for large projects such as office equipment, vehicles or construction. In most cases, banks are more willing to extend these loans to established businesses. Repayment may be on a monthly or quarterly schedule. Long-term loans are more likely to require collateral than short-term ones, and the collateral may be the item being purchased or, for capital funding loans, another asset of the business or its owner.

Advantages of a Term Loan

Term loans generally have lower rates than other types of loans. Fees are generally only about one percent and interest rates tend to be more reasonable. They do not always require collateral to secure them, although this is more common with short-term loans than longer term ones. In many cases, even if the item is being used as collateral, you can claim ownership for tax deduction purposes. Because the payments and in some cases the interest are fixed, they can be set as a specific business expense and are easily predictable. These loans are also readily available in terms of the number of lenders and institutions offering them and are, thus, easy to find.

Disadvantages of a Term Loan

In the case of new businesses, your personal credit history may be taken into account, and the application is very thorough. Although not all term loans require collateral, some do. Many banks also limit other financial liabilities your business can assume. This can include employee salaries, making it hard to attract qualified people. Other banks require that a set percentage of profits is earmarked for repaying the loan. If you personally secured a line of credit or working capital loan and your small business goes bankrupt, you may end up in personal bankruptcy or even losing your home. Because of this, financial advisors suggest personally securing a term loan only as a last resort if all other small business lending options are exhausted. However, if you want a loan backed by the Small Business Administration, you will have to personally guarantee it. If the interest rate is a 'floating' rate, it can change dramatically over the period of the loan. Also, some of these loans have a balloon payment, namely a very large payment that comes due when the loan 'matures'. This can force the business to renew the loan (and pay associated fees) if they do not have the money for the balloon payment, which can cause further problems for long term cash flow, especially if the loan was already over a longer period of time.