What is a Business Term Loan? 3 Ways These Loans are Different from What You Expected

Applying for your first business term loan can be stressful and intimidating. The terminology is unfamiliar, there’s a lot of paperwork involved, and there can be hurdles to face to get the funding you need.

In this article, we’ll look at one of the most common types of loans—the business term loan—and help you understand how it may be different than you expected, and when and why you should use it.

What is a business term loan?

A business term loan is a loan that provides you with a lump sum of money upfront that you borrow from a lender, then pay back at fixed intervals over a set period of time, with interest. Depending on your lender and the terms of the loan, you’ll pay off the loan on a weekly, bi-weekly, or monthly basis. Repayment periods can last from a few months up to 10 years or more, and funding amounts can range from $2,000 to $5 million. Much of this depends on creditworthiness.

Term loans remain one of the most popular ways for businesses to get funding. 53% of firms borrowing money stated loans are their choice for obtaining funds, according to the Federal Reserve Banks’ 2023 Small Business Credit Survey.

Like personal loans, these loans follow an amortization schedule. This means most of your payment pays interest at the beginning of the loan, and more principal near the end. Term loans can sometimes be repaid early, but that may come with a prepayment penalty.

Pros and cons of term loans

Term loans have many benefits that make them a great business financing option, but they aren’t right for every situation or every company, so you’ll also want to be aware of the cons.

Some pros of term loans include:

• You can borrow large loan amounts with flexible monthly payments.
• Long repayment terms can make loan repayment more affordable.
• Repaying term loans on time can build business credit, which is beneficial for new businesses.
• They can be unsecured, in some cases.
• The entire loan amount can be deposited quickly into a business checking account.

Some cons of term loans are:

• Term loans can be less flexible than a business lines of credit or business credit card.
• Term loans with a shorter repayment term can have higher costs.
• Some lenders charge an origination fee to process your application.

With any financing option, your business is taking on a certain level of risk. So be sure to weigh the pros and cons (including the interest rates you get) when making your decision about whether or not to take out a term loan.

3 ways term loans can vary

As lending has evolved in modern banking, term loans have also done the same. Here are a few things to know before selecting a loan and lender.

1. Term loans can come from different types of lenders

Historically, small businesses have had to go to a traditional bank or credit union for lending. In recent years, this trend has shifted. 49% of firms received financing from a nonbank financial company while 48% used a traditional bank or credit union, according to the Small Business Credit Survey. Both options have advantages and disadvantages.

Banks and credit unions can offer low rates on term loans but often have stricter eligibility requirements including strong personal and business credit score and strong business revenue. Bank term loans have long repayment terms of up to 10 years.

Online lenders offer speed, convenience, and slightly lower requirements compared to a bank or credit union. However, fees can sometimes be higher.

There are also term loans available the Small Business Administration for an SBA loan via traditional financial institutions and online lenders. These loans give established businesses lending facilities, but require similar credit approval.

2. Term loans have different term lengths

The length of your repayment term can have a big impact on whether this type of loan is a good financial decision. You’ll have to find a lender who offers you a term, payment schedule, and interest rate that make sense for your business. But unlike home mortgages, where you typically have a 15-year and a 30-year option, business term loans can be much more flexible.

Short-term loans

When companies are looking for quick business loans to mitigate a cash flow crunch, a short-term loan could be a great way to meet that need.

These loans have repayment terms of 12 months or less. Short-term loans are usually offered by online lenders and can offer you funding quickly. Although short-term business loans can be an easy online business loan to qualify for compared to other business term loans, they often have higher interest rates with larger payments required on a daily or weekly basis.

Click here to see how Bilal Bhatti used a short-term loan to fund his franchise expansion.

Medium-term loans

Medium-term loans generally have repayment terms ranging from one to five years for small business loans. These loans are available from online lenders as well as banks and credit unions.

Compared with short-term loans, there are stricter requirements to qualify for a medium-term loan, and come with more affordable interest rates.

Long-term loans

Although medium-term loans and long-term loans are sometimes grouped together, long-term typically refers to loans with a repayment period of more than five years.

Long-term loans take longer to get approved for but offer lower interest rates and ideal terms for financing large projects.

These loans are generally repaid on a monthly basis, with lower individual payments spread out over a longer repayment schedule. The total cost of debt, however, may be more overall compared with short-term or medium-term loans.

With terms of up to 25 years, SBA 7(a) loans are a common example of long-term business loans.

3. Term loans have a variety of uses

Traditional term loans can be used for a large variety of different financing needs. While some, like the SBA 7(a) or especially an SBA 504, are limited in scope, in general, you can get a term loan for the following purposes:

Real Estate

Since commercial real estate is typically a very large purchase, a term loan is frequently needed to make this type of investment. While most term loans and SBA loans, like an SBA 7(a) loan, can be used for real estate purchases, the SBA 504 loan, is especially good for this type of business expense.

The purpose of SBA 504 loans is to encourage job creation and community development, making them perfect for big investments, like buying real estate. These loans typically have low, fixed interest rates, long-term financing, and small down payments.

Facility Repairs or Expansion

Term loans can help you cover the costs of repairing or expanding your facility. Like buying real estate, repairing or expanding your existing facility or storefront is considered a “development” need for businesses, meaning a 504 loan also works well for this type of investment.

Since facility repairs and expansion may not cost as much as buying an entirely new property, you may have more flexibility in the type of term loan you get and the repayment length.

Equipment and Inventory

While you can use a line of credit or business credit card to purchase equipment, term loans may be a better financing option if you’re making a large investment. You can use traditional term loans from a bank or online lender for your equipment loans, or you might even be able to use an SBA 7(a) or SBA 504 loan, depending on your exact needs.

Working Capital

Working capital financing is commonly used to increase cash flow, meet payroll needs, pay rent, or make debt payments during a slow season.

Startup financing like a business line of credit or a merchant cash advance can be used for this type of financing. If you don’t need financing as quickly, term loans can still be an excellent option for working capital loans. An SBA 7(a) loan or a more immediate loan from an online lender may be useful here.

Refinancing or Paying Off Debt

If you previously took out a loan that doesn’t have favorable terms or you need to refinance, taking out a better loan can help you quickly pay off those old debts. Traditional term loans and SBA 7(a) loans can be used for this.

SBA loans can have a better rate than traditional term loans, but a traditional term loan can be easier to get.

What you need to get a term loan

Each lender will likely require this list of documents for a term loan application. It’s advised to gather these documents before you begin your application process to ensure a smooth application process.

• Credit report with your credit history and personal credit score from credit bureaus
• Records of how long you’ve been in business
• Bank statements from your personal and business bank accounts
• Proof of your annual revenue
• Business financial statements such as balance sheets
• Legal documents
• Business and personal tax returns
• Business plan

Keep in mind that each lender will vary somewhat in what it requires.

Wrapping Up

Term loans, whether traditional term loans or SBA loans, are a reliable source of funding for small business owners. Because they can come from such a wide variety of lenders and offer flexible repayment terms, term loans are an excellent financing option for business needs.

FAQs about business term loans

1. What is the typical term for a business loan?

   Business loan terms can vary widely from under a year to 10 years or more. This can largely depend on the funding needs your business has.

2. What is the best loan option for a small business?

   There are several loan options available for small business, including revenue-based financing, term loans, and more. The best option will be based on what fits your business needs and that you’re able to repay without financial constraints.

3. Why do businesses get term loans?

   Businesses get term loans if their financial needs are finite and short term. For example, if you have a one-time expense to upgrade your office, a term loan may be a great fit.

4. What is the difference between working capital and business term loan?

   Working capital is used for managing operational needs like covering payroll, while business loans are best used for growing a business like purchasing new equipment.

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