What Is a Term Loan and How Does It Work? (Alaska ‘18)
Originally posted on https://www.hercampus.com/author/what-term-loan-and-how-does-it-work
If you’re ready to finance your next dream business idea, term loans might be a realistic funding option for you to choose from. If you have a good credit history, a term loan can be a reachable and convenient option. But make no mistake; term loans aren’t all alike.
Want to learn more about what is a term loan and how it can help you? Keep reading here to learn the details on this funding tool so you’ll know more about their advantages as well as their disadvantages. Review them closely so you can find out which lending package works the best for you.
What is a Term Loan?
A term loan is offered by private lending companies as well as banks. When an individual or a business are approved for the loan, they must make either monthly or quarterly repayments for a pre-agreed upon period of time. Term loans will offer either fixed or floating interest rates.
Term loans can be classified as either short, intermediate or long term. A long term loan reimbursement period usually lasts for about three years or longer. Intermediate-term loan reimbursement schedules run between one and three years and short term loans can be repaid within a year and a half.
There are many benefits to term loans. Term loans can be reliable sources to help pay for significant investments like buying a new office building or hiring more employees to expand your business. These loans will also provide financing immediately if borrowers need access to additional cash then they can save by themselves.
Credit unions, online lenders and traditional banking institutions are all major sources for term loans. Each lender will have their own fees and loan terms for their loan products. It’s always best to secure any financial obligations in writing from each lender you might consider.
Here’s a more in-depth review of short, intermediate and long term loans. Each package contains its own benefits and disadvantages.
Short Term Loans
A short term loan is an adaptable term loan that can sustain a company’s short-term or immediate needs. These needs might include paying for unexpected needs or other unplanned emergencies. Other purposes might include paying off any lingering expensive debt or leveraging a larger financing option.
A short term loan can also help a company temporarily sustain cash flow or capitalize on an unforeseen business prospect.
Short term loan applications have a fast and simple application process. You can complete an online loan application from any bank or other lender. Borrowers will provide their tax returns, bank statements and credit scores.
A borrower will usually hear back within one to two days if they qualify. If they are qualified, the borrower, receives a lump sum of money immediately that needs to be repaid in 18 months or less.
A short term loan amount will be for around $5,000 or less. As mentioned earlier, a short term repayment schedule is also significantly shorter. Borrowers should expect to make daily or weekly payments throughout the loan duration.
A short term loan will also come with a high-interest rate. That’s because lenders don’t have as much time to review a potential borrower’s checking, credit, and business history to confirm that they are not a risk. A higher interest rate is the price you pay for the quick approval. It’s also an effective way a lender can protect their interests from a riskier borrower.
The main difference between intermediate-term loans and long term loans is their duration period. An intermediate loan period lasts up to around three years. An intermediate loan will have a fixed interest rate. This will allow a borrowing company to forecast payment terms and what the loan can cover over a period of time.
An intermediate-term loan has a rare quality about them. You can pay them off by using the profits you received from what the loan was used for. For example, you might need a loan to buy a new piece of equipment or temporarily hire a consultant.
Intermediate loan terms can include a waiting period for your new asset to gain momentum before you start making your loan repayments.
When that new piece of equipment starts to increase your profits, you can use those revenues to pay off the original loan. When that consultant shows you ways to improve your operations at a lower cost, you can use your intermediate-term loan to pay their final contract payment.
Intermediate-term loans can be difficult to qualify for. If you don’t have a good FICO score or strong cash flow or you are considered a safety risk.
Intermediate-term loan application periods also last longer than short term loan periods. Borrowers might be asked to guarantee collateral or other property as a way to secure their loan repayments.
You can find an intermediate-term loan offered through any traditional online lender, credit union or bank. They will usually loan borrowers up to $1 million. You can meet with a lender to see if their institution charges any origination fees or prepayment penalties for their loan products.
Origination fees are payments associated with establishing an account with a broker, bank or other lenders. These fees help offset the cost for these companies to provide you services for processing and managing your loan. Origination fees are usually a uniform amount for any kind of account.
Pre-payment fees are penalties a borrower pays if they pay their loan off ahead of the agreed-upon schedule. Pre-payment fees help the lender ensure that they will recover the interest they are owed, regardless if a borrower has paid off their debt ahead of time.
Long Term Loans
A long term loan has an affordable rate that is between six and seven times less expensive than an intermediate or short term loan. A long term loan will have a fixed interest rate. That means your monthly loan repayments won’t change much for the duration of the loan.
A long term loan also has a repayment schedule that accommodates monthly payments, unlike short term loans which may require weekly or daily repayments. Long term loan repayment amounts tend to be smaller than intermediate or short term loan repayment amounts. This could mean less stress on your bank account or current cash flow.
Long term loan repayment periods will depend on how the borrower plans to use the loan. Long term loan financing for general company expansion or working capital will usually see a term of around 10 years of less. Long term financing to purchase buildings or real estate can last as long as 25 years.
A long term loan can also be complicated to qualify for. It’s also difficult to secure a loan like these for any amount under $250,000. Banks will try and discourage any lower loan amounts because they spend the same amount in time and effort processing all loan sizes. That’s why it’s more profitable to them if they can issue a larger loan amount.
The US Government is also a long term loan provider for companies. The US Government won’t directly loan funds to a borrower. They guarantee the loan can be repaid to any lender.
One of these government-backed loan programs are managed by the US Small Business Administration (SBA.) The SBA creates policies for lenders to negotiate with a small company to manage these kinds of business loans.
A “small company” is defined as a business that will generate less than $750,000 in revenue and employ 250 people or less. Not every company can fit the “small business” definition.
The US Census Bureau website categorizes companies by industry to classify small businesses. Head over to their website to see if your business qualifies for an SBA long term loan.
Feel like you’re ready to try a term loan for your new company? If you do, then you should start the process today!
Regardless of the loan you apply for, collect your business financial statements and personal credit history right away. These are the first steps to apply for any term loan.
Review your current cash flow management process. Can you manage an aggressive repayment schedule like the one for short term loans? If you have immediate, less expensive purchases to make like repairs or new equipment, this loan product might work well for you.
Want to learn more about what is a term loan? Then check out our website. We can help you set your entrepreneurial dreams in motion in no time.