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What exactly is a term loan? When looking for funding for your small business, there are plenty of types of loans to consider, including term loans.These loans, which are paid back over a set period of time in regular payments, could be helpful for businesses looking to buy more real estate or equipment or even restock on inventory ahead of a busy season.Read on to learn the nuts and bolts of business term loans and their pros and cons.What Is a Term Loan?
With a term loan, a person or business takes out a lump sum amount of money from a lender and then pays back the loan amount through regular, fixed-interval payments. These are often monthly payments but could be weekly, bi-weekly or even quarterly. Part of a payment would go to principal, lowering the remaining loan balance, and part would go to the lender in the form of interest, which can be a fixed or variable rate.You’ve likely taken out a term loan for your personal finances (although you may not have heard it referred to in that way). That’s because mortgage loans, auto loans and student loans — as just three examples — are typically term loans.What Can a Term Loan Be Used For?
What you can use a term loan for ultimately depends on the lender. For example, if a financial institution only offers business term loans with collateral, then they likely wouldn’t approve a loan for some of the purposes listed here.With that in mind, here are some common uses for this type of loan for businesses:- Buying real estate or expanding or rehabbing property you already own (in that case, the real estate would likely serve as the collateral)
- Buying new equipment or repairing what you have (the equipment could serve as collateral)
- Restocking inventory, perhaps in anticipation of the holidays or another busy season, or if there’s great demand for certain products
- Buying vehicles for work, perhaps to deliver products
If a lender provides business terms loans without collateral, they could be used for a wide range of purposes, from meeting payroll and other expenses to covering employee recruitment costs to product development expenses and more.What Are Different Types of Term Loans?
As described above, small business owners may take out a term loan for a variety of purposes. So, that’s one way to consider types of term loans. Another way is through the loan term’s length: short, intermediate and long.Payments may be higher with short-term loans compared to when the payback period is longer (depending upon how much the business needs to borrow). When considering what your business can qualify for and pay back with its available cash flow, this needs to be factored in.Short Term
Short-term loans typically have a length of less than one year but their terms may go to 18 months or so. Businesses that don’t qualify for a line of credit might find this type of term loan helpful. Though these loans are typically easier to qualify for, they tend to have higher interest rates.A short-term loan may come with a balloon payment, meaning the last payment is much larger than the rest.Intermediate Term
Intermediate loans typically have terms between one to three years. Because of their slightly longer payoff time, they may be an option if you’re hiring a new salesperson, for instance, and know there might be some lag time before they start bringing in revenue. Like short-term loans, intermediate business term loans may also come with a balloon repayment structure.Long Term
As their name suggests, these loans’ terms can be much longer, perhaps even up to 25 years. Long-term loans typically require collateral, such as real estate or equipment. If the payments are large enough, these may limit your business’s ability to take on other loans.Also keep in mind that while long-term loans tend to have lower interest rates than those with shorter terms, they tend to be more difficult to qualify for, requiring proof of revenue and solid credit.How Do Term Loans Work?
After you’re clear about how much you need to borrow and for what purpose, then you can approach financial institutions to see what programs they offer, their interest rates and terms. You’ll also want to find out what documentation you’ll need in order to apply, what collateral might be needed and whether they can supply the funds on your timeline. Also check to see what fees may apply. Once you’ve evaluated all of the above factors, choose the lender that suits your needs and then apply for the loan. You can sometimes do this in person but often it’s online. Rates and terms offered can vary, based on the lenders as well as your personal and business credit history, time in business and financial health and history. If you’re approved for the loan, you would sign paperwork and then be free to use the funds. You’d then make regular payments based on the agreement.What Are the Pros and Cons to Term Loans?
Just as with any kind of loan, term loans have advantages and disadvantages. We cover the main ones here to help you make the right decision for your small business.Pros of Term Loans
Wondering what the upsides of term loans are? Pros of term loans include:- You may be able to borrow a large amount of money.
- Multiple types of term loan programs may be available when you look at different lenders.
- Interest rates are typically lower than credit card rates and those on payday loans and other short-term funding options.
- As you pay the term loan back on time, you can boost your business credit score.
Note: Check with your accountant or tax professional to see what tax benefits you may realize. Term loan interest may be tax-deductible. Cons of Term Loans
As with any financial product, there are downsides to consider as well. Cons of this type of loan include:- You may be entering into a long-term debt.
- The loan application process may take longer than you’d like.
- Some loans come with prepayment penalties, which means that you can’t prepay to reduce the amount of interest paid over the loan’s life, and other fees.
- If your credit isn’t the best, the interest rates you’re offered may not be, either.
Note: Because term loans are more often provided for established small businesses, here is information about loans for startups that may not yet have the financial history required by some lenders for business term loans. Check out insights into getting money to start a business. What Do You Need to Apply for a Term Loan?
When applying for a loan, documents often requested by lenders include:- Bank statements (personal and business)
- Tax returns (personal and business)
- Business legal documents, including licenses and permits
- Personal identification
- Business plan
- Revenue statements
- Accounts receivable reports
- Accounts payable reports
Because exact documentation required varies by lender and loan type (and whether collateral is involved), you’ll need to clarify what the lender you choose will need.The lender will then assess risk, usually looking at your business age, credit scores, revenue history, cash flow and debt-to-income ratio. Again, requirements can vary by lender. Many business loans, especially those with longer terms, may require collateral. If that’s not what you’re after, know that it is possible to get a business loan without collateral. Also, before you go straight to loans, it can be worthwhile to explore business grants (meaning, money you wouldn’t need to pay back).The Takeaway
When businesses are seeking funding, term loans are an option to consider. With a business term loan, the company borrows a certain amount of money in a lump sum and then pays it back in regular installments at either a fixed or variable interest rate. Terms can range from short (even under a year) to long (perhaps as long as 25 years), with the funds used for a variety of purposes.If you’re ready to start applying for small business funding, Lantern can be a helpful resource. When you apply at Lantern by SoFi, you only need to fill out one application to get an offer from a lender in its network. Photo credit: iStock/nortonrsx
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About the Author
Kelly Boyer Sagert
Kelly Boyer Sagert is an Emmy Award-nominated writer with decades of professional writing experience. As she was getting her writing career off the ground, she spent several years working at a savings and loan institution, working in the following departments: savings, loans, IRAs, and auditing. She has published thousands of pieces online and in print.
