'Term Loans' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Term loans refer to those loans a bank makes to a business or corporation for a set amount of time. These loans come with either a floating or a fixed interest rate and a pre-arranged schedule for repayment. There are numerous banks that offer such term loan programs to businesses so that they can access the funds they need for monthly operating expenses. Many times such a small business will utilize the cash they receive from this kind of a loan in order to buy equipment or other forms of fixed assets that they need for their production or manufacturing process.
Term loans are utilized for either working capital, purchases of real estate, or equipment purchases. These must be paid back in a time frame ranging from a single year on up to 25 years from issue. Payment schedules will either be quarterly or monthly. The maturity date will also be fixed on the loan. Actual interest rates could be pre-set or could vary with the floating interest rate benchmarks. Obtaining this kind of a loan will need appropriate collateral to be posted.
The approval process is exacting and extensive in order to lower the chances of default on such a loan. Small businesses which are established and that possess solid financial statements will find such loans to be appropriate for their situation. Banks will be more likely to approve them if the business is able to make a good faith down payment on the loan. This helps to lower the aggregate loan cost by reducing interest amounts and to decrease the minimum quarterly or monthly payment dollar amounts.
Funding amounts for these common commercial loans can range from $25,000 and higher. Bank loan officers usually subdivide such term loans according to one of two different categories. These are intermediate and long term loans. With intermediate loans, the loan maturity date is typically under three years. Such loans will commonly be paid back in monthly time-frame installments. There can be balloon payments due as well. Businesses expect to pay them out of their cash flow. The American Bankers Association states that repayment will typically be tied to the asset which is being financed and its useful life.
Conversely, longer term loans will last for more than three years and extend on up to ten or even 25 years long. The assets of a business will often serve as collateral for these bigger commitment loans. Usually either quarterly or monthly payments will come due. Businesses repay these installments utilizing either their cash flow or company profits.
Such longer-term commitment loans will generally come with clauses that restrict the number of other financial commitments the firm may assume in the form of debts, officers’ salaries, and dividend payouts. Sometimes they will mandate that a given percentage of company profits must be put off to the side in order to pay back the loan.
While there are countless ways a business could deploy the resources from a term loan, some are more appropriate. The smartest ways to use them are through important capital improvements to the business, construction projects, large investment in capital, or buying other businesses. Working capital is another sensible use for such a loan.
The rates for these types of loans are typically competitive and not expensive relative to other forms of borrowing. They commonly cost approximately 2.5 percentage points over the prime lending rate for those loans which will be shorter than seven years. For the ones that are longer-term than this, around 3 percentage points greater than prime rates is normal. There will also be fees for such loans that usually amount to around one percent. Construction loan fees are often higher.