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 they repay on a fixed repayment schedule.
Term loans can be helpful for businesses looking to expand, buy more real estate, update equipment, or purchase more inventory in advance.
So, what are term loans exactly? Read on to learn more about small business term loans, their advantages and disadvantages, and the different types of term loans available.
What Is a Business Term Loan?
A business term loan is a type of small business financing that provides a lump sum of money up front you then pay back over a set period of time, called a term. Payments are often monthly but could be weekly, bi-weekly, or even quarterly.
Part of each payment goes toward the principal, lowering the remaining loan balance, and part goes toward interest. Interest rates on business term loans may be fixed or variable. Repayment terms can range anywhere from 12 months to 25 years, depending on the loan amount, lender terms, and the borrower’s creditworthiness.
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 upgrading property you already own (the real estate would likely serve as collateral)
• Buying new equipment or repairing equipment you already own (the equipment could serve as collateral)
• Restocking inventory
• Buying vehicles for work
• Meeting payroll and other expenses
• Covering employee wages
What Are Different Types of Business Term Loans?
Most small business owners factor in two things when considering term loans — the purpose of the loan and the term length (there are short-, intermediate-, or long-term business loans).
Payments may be higher with short-term loans than long-term loans, though this depends on how much the business borrows. When considering what your business can qualify for and pay back with its available cash flow, remember to factor in how the length of your loan term affects the payment amount.
Short-Term Loans
Short-term loans typically have a length of less than one year but can extend up to 18 months. Businesses that don’t qualify for a line of credit might find short-term loans helpful. Though these loans are typically easier to qualify for, they tend to have higher interest rates.
It’s important to note that short-term loans may come with a balloon payment, meaning the last payment is much larger than the rest. Keep this in mind when deciding whether a short-term loan is right for your business.
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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 have a balloon repayment structure.
Long-Term Loans
Long-term loans typically have terms of five to 10 years, but they may extend up to 25 years. They typically require collateral, such as real estate or equipment, and may come with lower interest rates than short- and intermediate-term loans.
Long-term loans are often more difficult to qualify for, requiring proof of revenue and a solid credit history. However, they can provide helpful capital for business investments, making them a valuable option for established businesses planning for growth.
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How Do Business Term Loans Work?
Once you’ve determined the amount you need to borrow and the purpose, you can approach financial institutions to explore their available programs, interest rates, and loan terms.
You’ll also want to find out what documentation you’ll need to apply, what collateral might be required, and whether they can supply the funds on your timeline. Be sure to check what small business loan fees may apply.
Once you’ve evaluated the above factors, compare multiple lenders and choose the one that suits your needs. The loan application process typically happens online, but you may be able to apply in person if the loan is through a bank.
Rates and terms offered vary based on the lender, your personal and business credit history, your time in business, and your financial health and history. Pay particular attention to whether the loans you research are secured and how the interest rates are structured:
• Secured vs. unsecured loans: Secured loans require collateral or a personal guarantee, meaning that your assets will be used as payment if you can’t pay your loan. Unsecured loans do not require this collateral and are therefore riskier for the lender, so they often have higher costs and shorter terms than secured loans.
• Fixed vs. variable interest rates: A fixed interest rate remains stable over the entirety of the term loan. A variable interest rate fluctuates throughout the life of the loan, depending on the prime rate — the rate that commercial banks charge their most creditworthy borrowers.
If you’re approved for the loan, you are free to use the funds once disbursed. From there, you’d make regular payments based on the loan agreement.
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Deciding If a Business Term Loan Is Right for You
It can be challenging to decide which kind of loan is the right fit for your business. There’s a lot to consider. Here are a few questions to ask before applying:
• Why do I need funding?
• How does this help me reach my business goals?
• How healthy are my business finances?
And if any of these apply to you, it may not be time to consider term loans just yet:
• Your business is new
• You have poor credit
Business Term Loans: Pros and Cons
Like any other loan, business term loans have advantages and disadvantages that are important to consider when deciding whether they’re right for you. Below, we’ve outlined the pros and cons of term borrowing to help you determine whether term loans are a good fit.
Advantages of Business 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.
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Cons of Term Loans
As with any financial product, there are downsides to consider, as well. Cons 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 build 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.
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Disadvantages of Business Term Loans
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 business term loans come with prepayment penalties, which means 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.
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How to Apply for a Business Term Loan
Assess your business goals and lenders’ eligibility requirements as you choose the best option for your company. Here’s how:
1. Compare Small Business Term Loans
Comparing lenders’ terms can help improve your chances of qualifying for a loan. That way, you don’t spend valuable time applying for options for which you’re not eligible. On top of that, it helps keep you from overpaying on rates and fees or endangering your business cash flow with a repayment schedule that’s too aggressive.
2. 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
3. Scrutinize the Lender’s Fees
Also look at the fees side by side:
• Origination fees
• Late payment fees
• Early payoff penalty
4. Review the Repayment Schedule
Important 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 for their business term loans, meaning you need to make sure you can meet those standards. That way, you don’t overdraft your accounts, accrue late fees, or damage your credit score.
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5. Gather the Required Documents and Apply
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 the 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, it can be worthwhile to explore business grants since those do not need to be paid back.
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The Takeaway
When businesses seek funding, term loans are worth considering. 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?
Like other term loans, a business term loan provides a borrower with a lump sum of cash they repay on a fixed schedule over the set period of time, or term. The interest rate can be either fixed or variable.
What is an example of a term loan?
An example of a term loan is 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?
There are short-term, intermediate-term, and long-term loans.
Photo credit: iStock/pikselstock
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