Business term loans allow businesses to borrow funds that are repaid in installments over a set period of time with a fixed interest rate.
As a business owner, there are multiple ways to obtain necessary funding for your business. One of the most common types of business loans available is the business term loan. A business term loan offers access to borrowed funds that are repaid over a fixed period of time.
What is a business term loan?
A business term loan allows a business to borrow funds that are repaid in installments over a set period of time. Interest rates for term loans are usually fixed and do not change. This type of loan differs from other common types of business funding such as a business line of credit, which generally has varying payment amounts depending on your use of credit. The length of a business term loan can range from months to years, with one to five-year medium-term loans being the most common type.
Business term loans provide a predictable repayment schedule and often have favorable interest rates, making them a popular choice with many businesses. Term loans can be used to fund a variety of business needs, such as purchasing real estate, expanding a business, purchasing inventory or equipment, hiring new employees, refinancing debt, or performing renovations.
How does a business term loan work?
Once you are approved for a term loan, you will receive the entire amount of funds in a single payment. The repayment schedule of a business term loan depends on the lender and type of loan. Loans are typically divided into short-term, medium-term, and long-term. Repayment is usually weekly, biweekly, or monthly; for short-term loans, repayment may be required daily.
- Short-term loans typically last up to a year or 18 months and can be as short as three months. Businesses may need a short-term loan for handling an unexpected emergency or cash flow issue. Most often available from online lenders, short-term loans may require daily, weekly, or monthly payments. Fees and interest rates are usually higher for short-term loans.
- Medium-term loans are the most common type of business term loan, with a typical repayment period of one to five years. These loans are available from banks, credit unions, and online lenders and are typically more affordable than shorter-term loans.
- Long-term loans are those with a repayment schedule of more than five years and can be as long as 25 years. These loans are available in larger amounts and can be useful for business planning to undertake a major investment or project.
Interest rates for business term loans depend on the length of the loan and the type of lender, as well as your credit score, business revenue, and length of time you have been in business. Rates can range from three percent to 30 percent. Most lenders offer fixed interest rates, but occasionally, business term loans may have variable interest rates. It’s important to be aware of this as it means that your payment amounts could vary.
When evaluating your business for a loan, lenders typically consider your personal credit score, business credit score, revenue, and time in business. It may be more difficult to obtain a loan for businesses that have been operating for less than two years.
Where can you obtain a business term loan?
There are several main sources of business term loans. These include:
- Banks and credit unions. Banks and credit unions usually offer lower interest rates and fees, but they typically have fairly strict requirements for qualification, requiring businesses to have strong credit scores, successful revenue, and a longer time in business.
- Small Business Administration (SBA) loans. The SBA does not grant loans itself but guarantees loans from other lenders. SBA term loans often have low interest rates and offer long terms (up to 25 years). The agency also secures microloans for small businesses. SBA loans typically have stricter qualification requirements for businesses. The approval process for SBA loans may be lengthier than other loans.
- Online lenders. Online lenders are frequently able to approve loans more quickly and with less stringent requirements than other lenders, and they offer short-term loans that are not typically available from other sources.
What are the benefits of a business term loan?
Business term loans are common sources of funding for businesses. There are several benefits to this type of loan:
- They have lower interest rates. Because they are paid off over a long period of time, business term loans may have lower interest rates than other types of business financing.
- They are flexible. Business term loans can be used for most business purposes, including expanding your business, renovating, purchasing new locations, equipment, or inventory, hiring new staff, and debt refinancing. There are few restrictions on how you can use the capital from your term loan.
- They are stable and predictable. The set payment structure of a business term loan means that you will always know how much you owe each month. It is easy to financially account for this type of loan.
- They can improve your business credit. A strong history of on-time payments can improve your business’s credit score, making it easier for you to obtain other loans or financing in the future.
- Longer-term loans can help you fund large investments. A loan with a long repayment period can provide a large amount of funds that can be used for major investments.
What are the drawbacks of business term loans?
There are some disadvantages to business term loans.
- Startups and new businesses are often ineligible for business term loans. Business term loans typically require your business to have been operating for at least one to two years and have a certain amount of revenue. If you are starting a new business, this type of loan would not be suitable.
- There may be penalties for early repayment. Some lenders will not allow you to repay your loan early, and extra charges may be due if you do so. Other lenders will allow early repayment, so you will need to be aware of the rules of your loan.
- Short-term loans are often more expensive. Short-term loans typically offer higher interest rates and fees, making them more expensive than longer-term loans.
- Collateral or personal guarantees may be required. Many lenders require you to provide collateral or personal guarantees before lending to you. They may take a lien on your business assets. However, it may be possible to obtain an unsecured loan from some lenders.
Starleen Van Buren, MBA, is the director of El Camino College Small Business Development Center in Hawthorne, California. Larry Johnson, MBA, is the lead business advisor for the El Camino College SBDC. They provided answers and advice for business owners considering a term loan.
When is a term loan preferable to other types of finance?
Starleen Van Buren: Term loans are good for borrowers who have a one-time need for funds and want a fixed rate and term so that the payment doesn’t vary as it can with lines of credit. The borrower will know exactly when the loan will be paid off without having to worry about fluctuating payments.
Larry Johnson: Short, medium, and long-term loans are all designed to match certain asset lives and business cash flow realities. The nature of the funding need and the source of debt service payments should determine the nature of the funding instrument. If you are funding accounts receivable, it would be wise to select a loan structure that matches the asset you are financing. Receivables typically turn within 30 to 90 days; as such, the borrowing need will fluctuate over time. The outstanding principal will rise and fall, so a short-term facility is most desirable, perhaps a 90 or 120-day revolving credit. Even though the rate will be variable, the outstanding principal will be declining during the term and the impact of a variable rate is mitigated.
If you are funding a building or piece of heavy-duty equipment, your funding vehicle should be matched with the useful life of the asset, such as a 25-year commercial mortgage or a 10-year term loan for machinery, based upon a fixed rate of interest. Some assets or business needs may be more immediate or have a short life.
Many entrepreneurs use short-term loans (one to five-year maturity) for times when they need quick solutions to pressing circumstances. So whether you need to pay for unexpected expenses, hire new staff, endure a sales slump, replace a broken piece of equipment, or take action on an exciting business opportunity, a short-term loan can be a solid option, whereas longer-term, more permanent financing could be employed at a later date.
Are online lenders safe? How do they compare with traditional banks?
Larry: Online lenders offer a useful service for borrowers whose needs are straightforward and where the borrower is well versed in the instrument to be used and its terms. If you require significant support and hand-holding during the process, an online lender is not for you. A good analogy is the difference between making a hardware purchase at an old-fashioned neighborhood hardware store like Ace Hardware or buying your item on Amazon. The online purchase offers you significant cost savings, but with minimal support.
Starleen: As with anything, due diligence is important when seeking an online lender. It’s important to do some research into the online lender’s reputation for customer service and also do a comparison for rates, terms, fees, etc.
Online lenders are sometimes hard to contact, whereas a traditional bank usually has a brick-and-mortar location you can visit. So if there is a technical issue with your application or funding, it may be harder to get it resolved when you’re working with an online lender. Online lenders may have more competitive rates and terms because they don’t have the same overhead as a bank with a physical location.
Do you have any tips for people looking to receive first-time business loans?
Starleen: Maintain your business records and keep accurate track of your expenses and income. You may need a business plan, financial statements, and tax returns. Maintain your credit and pay your bills on time—that is so important.
Also, seek no-cost help from the SBA partners such as the Small Business Development Centers, Women Business Centers, and Veteran’s Business Centers. They offer no-cost assistance to help you get your business plan (if applicable), loan application, and documentation ready. They want to make sure you are bankable before visiting a lender. You can find the assistance closest to you at SBA.gov.
Larry: Take the time to keep your financial, accounting, and tax records up-to-date and accurate. Make sure your business has a system in place to keep everything organized.
Banks have different credit requirements, and good credit is an essential part of the process. Understanding the type of loan that works best for you is imperative. Banks want to see that you have demonstrated cash flow sufficient to make your monthly loan payments.
When you run a business, there are many situations where a loan is necessary. It’s important to understand the types of loans available to you and pick the option that works best for your business. Term loans are a common and flexible type of loan that can assist your business in many situations, whether you’re renovating your location, acquiring another company, purchasing new equipment, or need funds to deal with a sudden emergency.