What Is Term Loan Financing for Businesses?
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It can be challenging to grow your small business without the funds required to make the proper investments. If your business needs funding for growth initiatives, a business term loan is a great financing option. However, you may be wondering, “what is term loan financing?”
What Is Term Loan Financing?
With term loans, your business receives a one-time lump sum of money. You then repay the loan and the accumulated interest over a specific period of time. The interest rate on the business term loan can be variable or fixed. Furthermore, the interest rate is usually lower than the rates of other types of lending.
If you’ve ever had experience taking out a mortgage or personal loan, you may already be familiar with the term loan meaning. It’s a single upfront payment you receive from a credit union, bank, or online lender. The lender will send you funds, and then you pay off the loan with interest over a few months or years.
Business owners generally apply for term loan financing to finance certain one-off investments for their businesses, such as business expansion, debt refinancing, real estate purchases, and much more.
How Does a Business Term Loan Work?
With a business term loan, a lender sends you a lump sum of capital that you pay back with interest and fees over a set period of time.
Although the exact payment schedule depends on the type of business term loan and the lender who’s providing it, you’ll make equal payments throughout the entire duration of the term loan.
After choosing your business lender and being approved for the loan, you’ll need to agree to the repayment terms and rates. The repayment terms for a business term loan usually range from three to 10 years.
What is term loan financing interest like? Fixed-rate loans will have the same interest throughout the loan’s lifetime, while variable-interest loans have fluid interest rates. The rates you receive on your term loan will depend on many factors, which include your business and personal credit history, cash flow, time in business, and much more.
What Are Business Loans Used For?
In general, business loans are used to:
- Purchase equipment or inventory
- Finance working capital
- Hire staff
- Purchase real estate
- Fund long-term investments
- Meet payroll or tax obligations
- Refinance other business debts
- Finance business expansions
Lenders may choose to put restrictions on what they finance.
FURTHER READING: A Business Owner's Guide to Business Loans
Common Loan Terms and Rates
Generally speaking, business term loans have a one- to five-year repayment period. However, you can also find short-term loans with repayment periods of one year or less, as well as long-term loans with repayment periods of 25 years.
Nonetheless, most business term loans have a weekly or monthly repayment schedule. Shorter-term loans may require daily repayments.
When it comes to the interest rates on business loans, they will usually range from 7% to 30%. Bank and SBA loans may even offer interest rates lower than 7% if you’re an exceedingly qualified buyer.
Different Types of Business Term Loans
When applying for a business term loan, you’ll have to choose one of three periods:
1. Short Term Loan
A short-term loan typically lasts one or two years and is usually for a smaller amount of capital.
Short-term loans are best for financing working capital expenses. It’s also important to know that short-term business loans have higher rates since they are more convenient and easier to apply for.
2. Medium Term Loan
Medium-term loans, also known as intermediate-term loans, usually have a repayment period of two to five years. Usually, your business can access up to $500,000.
These loans are typically used by businesses looking to launch a new location or hire more employees. This level of funding can substantially boost and grow your business operations.
3. Long Term Loans
Long-term loans provide the greatest amount of capital and have the longest repayment terms. They typically range up to 25 years and allow you to access millions of dollars in term loan financing.
Long-term loans are ideal for established companies with a tremendous financial record and credit history.
Who Issues Business Term Loans?
Business term loans are issued by banks, credit unions, and online lenders. Make sure you shop around to find the best rates for your lending. Online lenders offer more flexibility and faster funding times but include more expensive rates with shorter terms.
Pros and Cons of Business Term Loans
With all financing options, there are pros and cons you need to consider before finalizing a decision.
Here’s a breakdown of the advantages and disadvantages of term loan financing:
- Ability to fund short-term financial needs
- Lower rates than other forms of lending
- Help you build your business credit
- Set payment structure
- Hard to qualify for
- Lenders may require collateral or a personal guarantee
- Lenders may charge additional fees
As you can see, finding the right loan is important, as the right financing will provide more pros than cons.
How To Know if a Term Loan Is Right for Your Business
If your business is looking for a financial injection, there are many options to consider. These include business grants, a line of credit, invoice financing, and so forth. Women-owned businesses also have more access to capital.
However, term loans are an excellent choice for a short-term expense or project. For example, if your business needs to purchase equipment or fund a marketing campaign, a term loan is an excellent option.
Furthermore, term loans are ideal for established businesses with proven financial track records. If your company has poor credit and doesn’t have many years of experience, it will likely be challenging to qualify for a term loan.
Term loans are also not a great option for businesses that need funding immediately, as the application process may take a long time.
How To Get a Business Term Loan
Although there are several options when it comes to finding a business term loan, you’ll need to evaluate your business first.
The specific business term loan requirements depend on which lender you choose. However, you’ll most likely need a minimum credit score of 600, minimum annual revenue of $100,000, and you will need to have been in business for at least one year to qualify for most loans.
Short-term loans require fewer qualifications and offer more flexibility, while bank and SBA loans require the highest degree of qualifications. However, the more qualified you are, the better your rates and terms will be.
Applying for a Business Term Loan
After determining where your business will likely qualify, you can begin preparing your business term loan application.
The application process varies from lender to lender. Banks will require extensive documentation and a paper or in-person application. Alternative lenders usually offer online and streamlined applications without much documentation.
However, here’s the information you can expect to provide:
- Personal and business information (drivers license, proof of ownership, business license, voided business check)
- Personal and business bank statements
- Business financial statements (balance sheet, P&L statement, etc.)
- Individual and business tax returns
- Personal and business credit score
It’s also vital to remember that most lenders will require you to sign a personal guarantee for the loan. Also, other lenders will take out a UCC-lien on your company's assets.
Before finalizing and signing the agreement, make sure you extensively review every detail to understand the fees, terms, and liabilities.
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