Term Loan

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DEFINITION of 'Term Loan'

A term loan is a loan from a bank for a specific amount that has a specified repayment schedule and a fixed or floating interest rate. For example, many banks have term-loan programs that can offer small businesses the cash they need to operate from month to month. Often, a small business uses the cash from a term loan to purchase fixed assets such as equipment for its production process.

A term loan is for equipment, real estate or working capital paid off between one and 25 years. The loan carries a fixed or variable interest rate, monthly or quarterly repayment schedule and a set maturity date. The loan requires collateral and a rigorous approval process to reduce the risk of default. A term loan is appropriate for an established small business with sound financial statements and a substantial down payment to minimize payment amounts and total loan cost.

Examples of Loan Types 

An intermediate-term loan runs less than three years, is paid in monthly installments from a company’s cash flow and may have balloon payments. The useful life of the asset financed has a hand in the repayment schedule. A long-term loan runs for three to 25 years, uses company assets as collateral and requires monthly or quarterly payments from profits or cash flow. The loan limits other financial commitments the company may take on, including other debts, dividends or principals’ salaries and can require an amount of profit set aside for loan repayment.

A Small Business Administration loan encourages long-term financing. Short-term loans and revolving credit lines are also available to help with a company’s short-term and cyclical working capital needs. Maturities for long-term loans vary according to ability to repay, purpose of loan and useful life of the financed asset. Maximum loan maturities are 25 years for real estate, seven years for working capital and 10 years for most other loans. The borrower repays the loan with monthly principal and interest payments.

A fixed-rate loan payment remains the same because the interest rate is constant; a variable-rate loan's payment amounts vary with interest rate changes. A lender may establish an SBA loan with interest-only payments during a company’s startup or expansion phase; the business then has time to generate income before making full loan payments. Most SBA loans do not allow balloon payments. The SBA charges the borrower a prepayment fee only if the loan has a maturity of 15 years or longer. Business and personal assets secure every loan until the recovery value equals the loan amount or until the borrower has pledged all assets as reasonably available.