The Basics of Term Loans for Business Owners
October 30, 2024 | Last Updated on: October 30, 2024
Disclaimer: Information in the term loan articles is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the term loan articles often covers financial products that Biz2Credit does not currently offer.
What You Need to Know About Term Loans For Business
When most people think about loans and how their repayment terms work, they are thinking of the traditional business term loan. They envision receiving one chunk of cash that is paid back with equal monthly payments. It may sound simple, but term loans for business come in many shapes and sizes. It’s important to have a good understanding of term loans if you’re a business owner thinking about borrowing money. Loans, like the ones mentioned above, are known as term loans. Once approved for a term loan, a person or business receives a lump sum of money, which is usually tied to a specific use like buying a home. The bank and borrower agree on a total loan amount, interest rate, fees, and the repayment schedule. The borrower makes regular payments that cover the principal (actual amount borrowed) and financing costs (interest and fees). So that’s pretty simple, but is it all there is to know about how business term loans work? There’s actually a lot more to it.
Term Loans for Small Business
The most common types of term loans for business that entrepreneurs will come across are intermediate- and long-term loans. Short term business loans are not included in this conversation, because short-term loans are treated differently than longer term term loans. They are designed to provide emergency or short term business funding and are repaid over a much shorter amount of time – sometimes a little as a few months. If you’re looking for short-term working capital for your business you may not even want to get a loan at all. Working through a forecasted cash flow statement may be all that’s needed to bridge that gap.
Intermediate-Term Loans
These loans:
- Typically have a term of less than three years
- Have larger loan payments
- Usually have smaller total loan amounts
Since intermediate-term loans for business are repaid quicker and may not be as large as their long-term cousins, they are typically issued for smaller purchases like equipment or vehicles. They may also require balloon payments, which are large payments at the end of a term loan to cover the entire borrowed amount or principal. That could mean you spend a couple of years making only interest payments and then have to pay a lump sum when your loan comes due.
Long-Term Loans
These loans:
- Have terms longer than three years
- Can have much larger overall loan amounts
- May require large amounts of collateral, like a property or other high-value asset
- May limit the borrower’s ability to have other financial obligations
With payments that are spread over a much longer time period, long-term loans for business may be made for much larger amounts. This makes them more suitable for very expensive projects or purchases, like building new facilities, purchasing equipment, or a buying an existing business. Most long-term loans will be amortized, which means that instead of paying interest every month and then owing a large amount of money at the end, you will be paying a fixed monthly rate that’s part interest and part principal. If you’ve ever had a mortgage, you’ll get how these long-term loans will work in the business world as well.
Where to Get Term Loans for Business
Traditional Lenders
Since term loans are common, it’s not difficult to find a lender that has several loan options available. Banks and credit unions are by far the most traditional of lenders in this arena, with banks usually offering more in the way of business banking options besides just loans. Traditional lenders are a great option for many small business owners. These lenders offer local and in-person branches for personal service. Having the ability to ask questions in person and make payments at a branch is important to many businesses, especially those with complicated or challenging financial needs. The tradeoff for this convenience and level of service is that banks and credit unions are limited by their size and ability to offer larger loan amounts, particularly for smaller community-based institutions. Traditional lenders like these are also very heavily regulated, which can restrict their ability to offer more customized financial products. They may also have specific lending policies that can prevent them from having too many loans to businesses in a certain industry or for a specific purpose. For example, many community banks closely watch their loan portfolios to avoid having too many funds tied up in things like commercial real estate or construction. The reason is to mitigate risk in the event of a natural disaster or sudden economic downturn.
Online and Alternative Lenders
We’re lumping these two together, because today most of the alternative lenders that you can find for your business are based online. Even though they’re not a bank or credit union, these lenders offer many of the same financial products. However, there are also several notable differences. The biggest difference is that most lenders offering online business loans don’t typically offer deposit products, like bank accounts. So, the funds they’re issuing come from other sources, like investors. The separation of loan funds from deposits means that there is no need to protect depositors from loan losses. This frees alternative lenders from much of the scrutiny that banks and other traditional lenders can face, allowing borrowers with low credit scores or less than perfect credit histories to still get approved. Alternative lenders usually offer one big benefit for small business owners when it comes to loans and financing: speed. A term loan process with an alternative lender will be much faster than you might find elsewhere.
Pros and Cons of Term Loans for Business Owners
Term loans have many upsides to consider when applying:
- Fees, interest rates, and payments are clearly outlined at the beginning of the loan period and don’t typically change over the life of the term.
- Loan amounts can be very large to meet the demands of growing businesses and large-value business transactions.
- Can be used for a wide variety of financial purposes, from building a new facility to purchasing a piece of equipment or a vehicle.
The downsides include:
- Borrowers can sometimes be charged for paying off their loans early, known as a prepayment penalty.
- Large loan amounts and huge amounts of debt can cripple a growing business for the life of the loan if the owners aren’t prepared.
- Loans with variable interest rates can grow to be very expensive over time.
Getting a Business Term Loan
Borrowers are evaluated on several eligibility criteria when applying for term loans for businesses. This usually includes:
- Business financial history
- Personal credit history
- Current financial situation
- Business needs
- Years in business
- Annual revenues
- Existing financial commitments
- Strength of business plan
Alternative lenders, or online lenders, may have special programs or be able to offer loans to people and businesses who don’t meet the typical picture of a perfect borrower. The best way to find the small business loans is through research and reading reviews or testimonials from other business owners that have experience with the organization. Even traditional term loans from a bank or credit union can be very expensive and may not be the best choice for a growing business, so it’s important to understand the options that are available before making a commitment to a years-long term loan. Exploring other business financing options, like a business line of credit or government backed-funding, like SBA loans, which are partially backed by the U.S. Small Business Administration, is also recommended for business owners seeking capital.
FAQs
Will I get approved for a term loan at Biz2Credit?
To qualify for a term Loan, your business must meet eligibility requirements. Once you go through the loan application process, we will let you know if you are eligible for a Term Loan.
Can I get a term loan for a startup business?
Most lenders require two years of business financial statements to approve an unsecured term loan, but there are other options to getting approved for a term loan like choosing an SBA loan, or using collateral or a personal guarantee to secure the loan.
How much can I borrow?
The total loan amount to apply for should depend on your specific business needs and the borrower’s creditworthiness. There are revolving credit financing options, like a line of credit or business credit cards, that allow borrowers to only withdraw the funds they need at a time.
Will a term loan hurt my business credit score?
No, taking out a term loan and making timely payments helps new business owners build good business credit.
Are the funds from a term loan restricted?
No, term loans typically have few restrictions, allowing you to use the money for a wide range of business needs.
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