Term Loan

Term loan is apparently one of the most usual forms of debt. In the context of business, a firm that obtains a term loan receives a lump sum that must be repaid over a predetermined period of time and interest. 

How does a term loan work?

• Fixed loan amount: the size of the term loan is fixed. Based on the type of term loan and whether the firm meets the lender’s eligibility criteria, the actual loan amount may vary.
• Fixed repayment tenor: when obtaining funds from a term loan, startups are obliged to repay the loan within the predetermined period which can be short, intermediate, or long-term.
• Collateral may be required: term loans can be secured or unsecured depending on the borrower’s eligibility and amount acquired.
• Fixed or floating interest rate: a fixed or variable interest rate can either be used on term loans, depending on the choice of the borrower.
• Fixed repayment schedule: upon receiving the funds, the borrower must pay equated monthly installments (EMIs) derived from a repayment schedule.
• Common fees: Facility fee/commitment fee, prepayment fee, unused fee.

Types of term loans

As Mentioned earlier, term loans are classified based on their tenor structure, they are:

Short-term loans

Short term loans usually mature less than one year, but it can go up to 18 months. They are used with a particular purpose, mostly to meet unforeseen cash shortfalls. Either protecting a loss, which increases cash flow, or making a high profit from the utilization contract are both aided. It can occasionally be used as working capital in the manufacturing sector for the acquisition of inventories.

Intermediate term loans

A foreseen need becomes an intermediate term loan with a payback duration of 1 to 3 years. Repayment may come from a variety of sources or from profits made on the loan amount. Buying a car might not result in a direct profit, but it will increase business facilities.

Long-term loans

Loans with long payback terms, up to 30 years, are usually available with low interest rates. Despite the small amount of the EMI payments, there are several tax advantages in the form of interest deductions. Long-term loans are thus an efficient option for corporations to meet one-time financial needs. They can impose restrictions on the amount of additional loans, dividends, or principals' salaries the business can incur, as well as the amount of profit that must be put aside especially for loan repayment.

Why and how do firms apply for term loans?

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Small firms that require funding for equipment purchases, a new facility for their manufacturing processes, or any other fixed assets to maintain their operations frequently receive term loans. Some companies take out monthly loans to get the money they require to operate. To especially assist businesses in this way, several banks have created term lending programs.

The same as with any other credit facility, business owners apply for term loans by contacting their lender. They must offer documents proving their creditworthiness, including statements and other financial proof. A large sum of money is given to accepted borrowers, who then have a certain amount of time to pay it back, often on a monthly or quarterly basis.

The repayment schedule may be impacted by the asset's useful life if the funds are utilized to finance the acquisition of an asset. To lower the risk of default or missed payments, the loan needs security and goes through a thorough approval process.

To lower the monthly payments and overall cost of the loan, large down deposits may be needed for term loans.