Most small businesses have trouble keeping cash flow steady at some point. That’s where business loan financing, like a term loan, can come in handy: taking out a loan can help you have working capital for business expenses so you don’t jeopardize your hard work.
What is a Term Loan?
A term loan is a type of financing that provides a fixed sum of money to a borrower. The funds are repaid over a period of time at an agreed-upon interest rate.
What Are the Types of Term Loans?
When it comes to term business loans, there are three primary types:
- Short-term loans
- Intermediate-term loans
- Long-term loans
Short-term loans are typically paid back over a year or two. A payday loan or invoice financing from an online lender is a good example. These loans tend to have higher interest rates, though you don’t necessarily need great credit to qualify.
Loans with an intermediate-term have longer repayment periods, usually up to three years. These may be for larger loan amounts and might be secured loans, like equipment financing.
A long-term small business loan will have a repayment term of five to 10 years, typically. This is the kind of loan that traditional banks and credit unions will offer, though you will also find some online lenders offering them. SBA loans are a good example of long-term loans.
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Pros and Cons of Term Loans
A business loan is great for many companies, but not all. Depending on your needs, you might be better off with a line of credit or business credit cards.
- Help keep cash flow steady
- A wide range of interest rates and terms available
- Options from different types of lenders
- Those with bad credit won’t qualify for the best rates
- Debt may keep you from other opportunities
- There may be other fees involved
Pros of Term Loans
The first benefit of term loans is that they afford you the ability to manage your cash flow. Just because you have funds in your bank account doesn’t mean you necessarily have to spend them on, say, heavy machinery, and leave your account dry. By financing a purchase, you still have cash on hand should an emergency occur.
Today’s lenders are vastly different from what they were even a few years ago. Banks aren’t your only option, and it’s a good idea to shop around for the lender who offers you exactly what you need. If you don’t qualify for a bank loan, you likely will qualify for a loan with an alternate lender, so there’s something for everyone.
Cons of Term Loans
Unfortunately, if you don’t have excellent credit as a borrower, you won’t qualify for the lowest interest rates. You’ll pay more for the privilege of having access to capital, but if you need it, it’s probably a price you’re willing to pay.
Having debt on your credit report might impair you from taking out future financing or attracting investors, so that’s something to keep in mind.
And be aware that in addition to the interest you’ll pay on your debt, you may also be required to pay an origination fee or other fees that add to the cost.
How Does a Term Loan Work?
With a term loan, you borrow a specified amount of money and agree to pay a fixed amount each month over the loan period. You may have a variable interest rate or a fixed rate, and your loan may be secured, meaning it requires collateral, or unsecured. All these factors will depend on who you apply for a loan with and what your loan terms are.
Each month, you will make both principal and interest payments. You might send a physical check to your lender for your repayments or set up autopay. If you miss a payment, you may be charged a late fee. If you miss multiple payments on your bank loan, the lender may put you in default.
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What Can a Term Loan Be Used For?
Business loans can be used for a variety of purposes in your business, from maintaining cash flow to purchasing equipment, making payroll, expanding your business, or consolidating debt.
Note that some loans will require the funds to be used for specific purposes, so see what parameters are involved before applying.
What Does It Take To Qualify For a Loan?
Qualifications will vary from one lender to another. Each bank, credit union, or online lender will have different data points it uses to determine whether you qualify for a business term loan, at what interest rate, and with what repayment terms.
More than likely, your personal and business credit scores will be a part of that equation. Some lenders require high scores, while others use different factors, like your ability to repay the loan, your accounts receivable, or your income to debt ratio. (Learn how to establish business credit before you apply.)
For secured loans that require collateral, you may be able to get a lower interest rate and therefore lower monthly payment, since if you default on the loan, the lender can seize the asset and therefore has less risk.
How To Apply For a Term Loan
Term loans work like other types of business bank loans: you start by applying through a lender. You’ll need to specify how much money you want. A short-term loan application may require no more details than borrower contact details, how much revenue you generate, and your expenses.
For a long-term loan, the application may be more involved. You may need to provide credit references and financial reports.
Just like with personal loans, once you complete your application, the lender might ask for additional documentation before making you an offer. Once you sign your loan agreement, the funds will be deposited into your business bank account. Repayment will begin the next month.
Nav’s Verdict: Term Loans
When it comes to business loans for small business, there’s a wealth of options for term loans. No matter what your credit situation or what kind of loan payment terms you’re looking for, there is something for you.