What is a Term Loan?
A term loan is a loan that offers a business capital expenditure and expansion for 84 months.
How are Term Loans Beneficial?
- A term loan gives borrowers a significant amount of money upfront in exchange for specific borrowing terms.
- Borrowers can agree to pay their lenders a set amount over a period at a fixed or floating interest rate. It provides greater flexibility and cheaper interest rates.
- Small firms can use term loans to purchase fixed assets such as equipment or a new building.
Factors to Consider Before Acquiring a Term Loan
- The five components of a term loan are the loan amount, interest rate, length, repayment schedule, and whether the loan is secured or unsecured.
- There is a fixed repayment value for the loan based on the type of loan chosen and the borrower’s eligibility.
- The interest rate on this business loan could be fixed or variable. It is totally up to the borrower to choose a rate.
- There is a fixed loan term. Throughout the loan term, the company must repay the loan amount in EMIs according to the repayment schedule.
- The loan requires security and a stringent approval process to limit the risk of default or nonpayment. However, if you pay up a term loan ahead of time, there are usually no penalties.
Features of Term Loans
Term loans are secured loans. Assets financed by term loans serve as primary security, while the company’s other assets serve as collateral security.
Borrowers must pay interest and repay principal on term loans. Whether the company makes a profit or not, term loans are typically repayable in instalments over a 5- to 10-year period.
Although term loans have a set interest rate, it is negotiable between the borrowers and lenders at the time of loan disbursement.
Because it is a medium-term financing source, its maturity length ranges from 5 to 10 years, with repayment done in instalments.
Aside from asset security, the lender of the term loans puts extra restrictive covenants on themselves. For example, borrowers are asked to maintain a minimum asset base, not to obtain more loans or repay existing loans, and so on.
At the financial institution’s discretion, they may convert the term loans into equity.
Types of Term Loan
There are various types of term loans based on the factors:
- Required funding amount
- Borrower’s repaying capacity
- In-hand fund availability
And the classification can be listed as follows:
A short-term loan meaning a term loan, is a loan that a bank offers for a short period of 12 to 18 months.
- Lenders consider the tenure to be five years to 84 months.
- Borrowers consider the tenure to be very short.
Intermediate loans are term loans with a longer tenor of 84 months, and businesses use them for big-budget funding needs.
Long-term loans come with extended tenors, and borrowers or lenders use them for lump sum funding.
Advantages of Term Loans
From the Borrower’s Point of View
- Expense: It is a less expensive medium-term financing source.
- Tax Advantage: Because interest on a term loan is a deductible item, there is a tax advantage on interest.
- Adaptable: Term loans are loans between borrowers and lenders. As a result, the terms and circumstances of these loans are not restrictive, allowing for some flexibility.
From the Lender’s Point of View
- Assured: Banks and other financial institutions make secure term loans in exchange for collateral.
- Regular Income: The borrower has to pay interest and return principal regardless of financial status, ensuring the lender obtains consistent and consistent revenue.
- Adaptation: To minimise default, financial institutions may demand borrowers convert term loans to equity. As a result, they may be responsible for the company’s affairs.
Disadvantages of Term Loans
- The firm is legally required to pay the fixed interest and principal amount to the lenders, failing to which could result in bankruptcy.
- Debt financing, particularly term loans, increases the firm’s financial leverage, raising the firm’s equity cost. As a result, if inflation falls to shallow levels, the actual cost of debt will be higher than projected.
Documents required for Term Loans
You should keep the following documents handy while applying for a term loan:
- Business registration proof
- KYC documents
- Bank statement for the last six months
- Pan card
- Aadhaar card
Term Loans Offered by Banks
- Long-term loans are small amounts for a long repayment tenure, requiring similar eligibility criteria and documents to other long-term loans. Therefore, they are best suited for the urgent financial needs of customers who wish to pay in small instalments over a substantial repayment period.
- Small business loans are for businesses to expand, requiring credit in loans with tenure over three years.
- Home loans have tenure beyond three years, and the loan amount is considerable. Therefore, the person needing the loan should submit collaterals to the bank and choose between fixed and floating interest rates.
- Car loans have high-interest rates than home loans, with a long-term payment tenure of up to 7 years.
- Personal loans have a payback term of more than three years and a not-so-low interest rate because they are unsecured.
- Education loans are for those wishing to go for higher studies in India and abroad for an extended period (like three years), especially for courses like engineering and medicine, which can go up to 30 years.
FAQs on Term Loan
What exactly is a term loan?
A business obtains a term loan, typically from a bank, in which they intend to borrow an amount, and the bank defines that amount.
Why are term loans granted to businesses?
Businesses sometimes want cash for various reasons, and these loans are provided to corporations to cover their cash needs. These requirements could cover operating capital needs or fund a new project. It could also mean purchasing new machinery or constructing a new production facility.
What is an example of a term loan?
A working capital loan is an example of a term loan for businesses that want quick finance to maintain cash flow or pay day-to-day business expenditures.
Is a car loan a term loan?
Yes. A car loan is a term loan because a bank grants it for a set period, such as five, ten, or fifteen years.
What are the different forms of term loans?
1. Short term: Loans ranging from a few days to a year
2. Medium-term: loans ranging from a year to 18 months and up to 84 months
3. Long-term: loans lasting from 84 months to 25 years
Can a company get tax exemptions for money contributed toward loan repayment?
Yes, the interest component of the EMI (equated monthly payment) is tax deductible for a firm that has taken out a term loan. Your loan payment's interest component is something you can deduct as a business cost. As a result, it aids in obtaining tax exemptions for the firm because it is removed from a business's gross income, lowering taxable revenue.