When looking for funding for your small business, there are plenty of types of loans to consider, including term loans. A term loan provides a borrower with a lump sum of cash that’s repaid on a fixed repayment schedule.
Term loans could be helpful for businesses looking to expand their business, buy more real estate, update equipment, or purchase more inventory in advance.
Read on to learn more on small business term loans, their pros and cons, and the different types of term loans available.
What Is a Term Loan?
With a term loan, a person or business takes out a lump sum 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 the 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.
Term loans aren’t just used for small businesses, though. Mortgage loans, auto loans, and student loans are also all types of term loans.
What Can a Term Loan Be Used For?
Common uses of term loans for businesses include:
• Buying real estate or rehabbing property you already own (in that case, the real estate would likely serve as the collateral for the loan)
• 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
• Buying vehicles for work
• Meeting payroll and other expenses
• Covering employee wages
What Are Different Types of Term Loans?
Small business owners may take out a term loan for a variety of purposes, which is 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 Loans
Short-term loans typically have a length of less than one year. They may extend to 18 months. 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.
Recommended: Cost of Capital
Intermediate-Term Loans
Intermediate loans typically have terms between one and 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 Loans
Long-term loans typically have terms of five to 10 years, but they may go up to 25 years. They typically require collateral, such as real estate or equipment, and may come with lower interest rates compared to short- and intermediate-term loans.
Also keep in mind that long-term loans typically tend to be more difficult to qualify for, requiring proof of revenue and a solid credit history.
Recommended: Merchant Cash Advance for Bad 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 their loan 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 small business loan fees may apply.
Once you’ve evaluated all of the above factors, comparison shop multiple lenders and choose the lender that suits your needs. Applying for the loan is typically done online, but may be able to be done in person if you’re applying with a bank.
Rates and terms offered can vary based on the lender, your personal and business credit history, your time in business, and your financial health and history.
If you’re approved for the loan, you would sign paperwork and then be free to use the funds once disbursed. You’d then make regular payments based on the loan agreement.
Recommended: How to Check Your Credit Score for Free
What Are the Pros and Cons to Term Loans?
Just as with any kind of loan, term loans have advantages and disadvantages.
Pros of Term Loans
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 cards, 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.
Recommended: What Are the Tax Benefits of a Limited Liability Company (LLC)?
Cons of Term Loans
As with any financial product, there are downsides to consider, as well. Cons of term loans 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.
• If your credit isn’t the best, the interest rates you’re offered may not be, either.
Recommended: Debt to Income Ratio
Applying for a Term Loan
Be sure to assess your business goals and lenders’ eligibility requirements as you choose the best option for your company.
Compare Small Business Term Loans
Comparing the lenders’ terms helps you improve your chances of qualifying for a loan and saves you time by helping you avoid applying for options for which you’re not eligible. On top of that, you want to make sure you’re not overpaying when it comes to rates and fees, or endangering your business cash flow with a repayment schedule that’s too aggressive.
Look at Each Lender’s Eligibility Requirements
It’s helpful to examine these requirements side by side:
• Personal and business credit
• Time in business
• Annual revenue
• Collateral
• Down payment
• Personal guarantee
Scrutinize the Lender’s Fees
Also look at the fees side by side:
• Interest rate and APR
• Origination fees
• Late payment fees
• Early payoff penalty
Be Sure You Understand Repayment Schedule
Questions to ask:
• Are payments made daily, weekly, monthly, or quarterly?
• Are payments automatically deducted from a business bank account?
Many lenders have strict repayment terms, meaning you need to make sure you can meet those standards so you don’t overdraft your accounts, accrue late fees, and damage your credit score.
Recommended: Long-Term Small Business Loans
Documents Needed 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.
Also, before you go straight to loans, it can be worthwhile to explore business grants since those do not need to be paid back.
Recommended: What Are Small Business Grants?
The Takeaway
When businesses seek 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 seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
FAQ
What does “term loan” mean for a business loan?
A term loan provides borrowers with a certain amount of cash upfront in exchange for specific borrowing terms. Borrowers agree to pay their lenders a fixed amount over a certain repayment schedule. The interest rate can be either fixed or variable.
What is an example of a term loan?
A small business loan of $50,000 from a bank that has to be paid over three years in monthly payments, with fixed interest.
What are the three main types of term loans?
They are short term, intermediate term, and long term.
SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOSB0224008