The Pros and Cons of a Term Loan
You understand the significance of investing in new growth prospects since you are a company owner. But sometimes you may not have the necessary funds on hand to make these investments. Small company funding may save your life in this situation.
You may have thought about taking out a term loan if you’re seeking for funding. But it’s crucial to comprehend what this kind of loan is and how it varies from other available possibilities before making a decision.
Also Read: Struggling for Cash Flow? Strategies for Survival
What is a term loan?
You already know how a term loan works if you’ve ever taken out a mortgage or personal loan. From a bank, credit union, or online lender, you get a one-time upfront payment.
The lender gives the money, and you pay back the loan over many months or years with interest. The interest rate, which may be fixed or variable, is often less expensive than that of other forms of financing.
Term loans are available for both private and commercial purposes. For one-time projects or to foster long-term company development, many business owners ask for term loans.
How do term loans work?
Through a bank, credit union, or internet lender, you may apply for a term loan. The best rates are often provided by banks and credit unions, although their qualifications might be more onerous and they have stricter restrictions.
While the rates charged by an online lender may be higher, the application procedure is simpler, and cash is often granted more quickly. Additionally, if you decide to apply via a lending marketplace, you will only need to submit your application once and will then get offers from several lenders.
You must consent to the interest rates and repayment conditions after selecting a business lender and receiving loan approval. Your personal and corporate credit histories, cash flow, and length of time in operation are among the variables that will affect the rates you obtain.
A company loan normally has a payback period of three to ten years. If you are given a fixed-rate loan, your interest rate will remain constant during the loan’s term. Your rate will fluctuate with a variable-interest loan on a regular basis.
What is a term loan example?
Long-term loans and short-term loans are the two main categories of term loans. Your business’s demands for funding and the sort of loan you apply for will determine which one you get.
An excellent illustration of a term loan is one provided by the Small Business Administration (SBA). Your SBA loan application might be approved for up to $5 million if you submit it. Your rates will be set by your lender, but they cannot be higher than what the SBA would allow.
Naturally, not all companies need that level of funding, thus the SBA also provides 7(a) modest loans. The maximum loan amount is $350,000. SBA loans usually have a fixed interest rate and a predetermined term.
A term loan may be used to support new marketing initiatives, equipment purchases, and company operations expansion. Term loans enable businesses with limited cash flow to invest in fresh prospects and increase their possibilities of generating more money.
What are the benefits and drawbacks of term loans?
Term loans, like other lending solutions, have advantages and disadvantages that you should take into account before making a choice.
- They can meet demands for emergency funding. A term loan might be an excellent choice if you need to buy new assets or equipment for your company. You may take advantage of the chance to expand your business, and the money you make from doing so will help you pay back the loan.
- Their rates are often lower. Term loans often have low interest rates and a range of repayment options. The loan may be repaid over the required period of time without placing an undue financial strain on your company.
- They aid in establishing company credit. A term loan may be an excellent approach to improve your small company credit, provided you make your regular payments on schedule.
- They need a fair amount of qualification. Term loans are often more difficult to qualify for than other loans because of their advantageous rates and payback durations. You must provide your lender comprehensive financial details and a stellar credit history.
- Some lenders may demand security. Your lender can ask you to put up some kind of collateral if they believe your company poses a financial danger. Your personal or corporate assets are at danger if you are unable to repay this secured loan.
- They could levied more fees. For term loans, some lenders impose extra expenses, such origination charges. If you pay off the loan earlier than expected, the lender may even impose a prepayment penalty.
Types of term loans
You may apply for a short-term, intermediate-term, or long-term loan if you determine you need a term loan.
These are loans that are available for modest sums and have one- to two-year payback terms.
Working capital costs on a daily basis are ideal for short-term borrowing. However, you can anticipate to pay higher rates since these loans are more accessible and simpler to qualify for.
The ideal loan length is somewhere in the middle, between short and lengthy terms. You have access to up to $500,000 and the payback periods are normally two to five years.
These loans are a wonderful choice for companies wishing to expand by hiring additional staff or opening new locations. You may be able to grow your company operations and start bringing in more money with the aid of this form of investment.
The greatest loan amounts and the longest payback durations are provided through long-term loans. Millions of dollars in financing are available to you, with up to 25 years for payback.
An established firm with outstanding credit and a strong track record financially is a suitable candidate for a long-term loan. You can take into account one to finance your company’s long-term expansion plans.
When to consider a term loan
There are several choices available to you if you’re thinking about startup finance. How can you determine if a term loan is better for your company than, say, a revolving line of credit?
Generally speaking, a term loan is a wise decision for a brief project or expenditure. For instance, a term loan might assist you in paying for expenses like inventory purchases or marketing campaign investments.
Term loans work best for well-established companies with a track record of sound financial management. For those with bad credit or no company experience, being approved for a term loan could be too challenging.
Term loans are the greatest option for organizations that don’t want cash right now. Applying for a term loan might take some time, particularly if you want to benefit from the bank or credit union’s low rates. Therefore, a term loan may not be your best choice if you require quick access to money.
How to apply for a term loan
The actions you must take to submit an application for a term loan are as follows:
1. Get your paperwork in order.
Organizing your financial data before you apply for the loan is a smart idea. The specific criteria differ from lender to lender, however the following is a summary of the data you might anticipate to provide:
- Employer identification number (EIN)
- Personal and business credit history
- Business tax returns
- Bank statements
- Profit and loss statement
- Income statement
2. Apply with multiple lenders.
The whole cost of the loan should always be considered when applying for a term loan. If the interest rates are too high and your investment doesn’t bring in a lot of extra money, you can find yourself in default on the loan. Applying with many lenders will allow you to compare interest rates and repayment conditions and get the most inexpensive loan for your company.
You won’t need to worry about it harming your credit score since many lenders will preapprove you for a loan with only a light credit check. Additionally, by submitting a single application via a loan marketplace, you might get various offers.
3. Compare your offers.
Once many lenders have made you offers, consider each one. Although it may be alluring, you should think about a few other factors before choosing the lender that gives you the largest loan amount.
The annual percentage rate (APR), which will assist you in calculating how much it will cost you to borrow the money, should be carefully examined. You should also consider the conditions of repayment since they will have a big influence on your capacity to pay back the loan.
Additionally, it is crucial to pay particular attention to any costs the lender levies. It is simple to ignore the costs if the loan has a low interest rate and flexible repayment periods, but they may raise the cost by hundreds of dollars over the course of the loan. The following key costs should be watched out for:
You must pay the lender an origination fee up front in order for the loan to be processed. From 1% to 5% of the entire loan amount is charged in these costs.
Some lenders impose a penalty fee because they lose out on future interest payments if you pay off the loan early.
You’ll incur an extra charge for making your monthly payment later, as with the majority of monthly expenses.
The price of underwriting the loan is covered by a processing charge.
4. Close on the loan.
You are prepared to close on the loan and get the money after you have selected a lender and accepted the conditions. You could get the money a day or two after the closing, depending on the lender.