What is Term Loan
A term loan is basically a certain amount borrowed from a bank and has a predetermined repayment schedule. Term loans are offered by banks and financial institutions at either floating or fixed interest rates. If you have ever taken a home loan or a car loan, you have already availed a kind of term loan. Basically, the “term” in the term “term loan” is the time period in which the borrower will have to repay the loan.
Term loans are generally ideal for small businesses, established and start-ups alike. Business owners can avail a term loan to purchase assets, vehicles, or equipment. The repayment term of the loan will be calculated by the useful life of the asset for which the individual took the loan. For instance, an equipment such as a copy machine or a computer will have to be repaid within a period of 2 to 3 years. Land and building, on the other hand, when purchased through a term loan, have repayment tenures that can extend up to 25 years. These loans can be secured or unsecured depending on the borrower and the lender.
Approval Rates for Term Loans
Small businesses usually find it difficult to avail term loans from the big banks as there are many obstacles in the approval process. A survey conducted in January 2014 shows that only around 20% of the small businesses seeking term loans from major banks were approved. Smaller banks, however, are less stringent when it comes to approving loans from small businesses. The same survey showed that around 50% of the businesses that applied for term loans with small banks were approved.
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Why go for a Term Loan?
Although credit cards can be effective to meet immediate expenses such as the purchase of office supplies or travel, and credit lines are mainly used for cash flow management, going for a term loan can help you effectively deal with high-cost purchases that could be beneficial for your company in the long run. The most common reasons for taking a term loan are as follows:
- Purchase of machinery, equipment and other tools for repair, and service and manufacturing purposes
- Purchase of office space and real estate, and to meet expenses related to construction and renovations
- Technology and other office equipment like phone systems, POS systems, furniture, computers, etc.
How do Term Loans Work?
Term loans are generally availed for the purchase, acquisition, installation or construction of capital assets, to finance working capital requirements, or to purchase real estate. While some businesses avail term loans to buy fixed assets like new equipment for operating the business or new buildings to carry out their production processes, some businesses avail term loans to meet the daily expenses associated with running the business. A good number of banks have designed term loan schemes that specifically help companies with their financing needs.
Borrowers can choose the repayment tenure based on their ability to repay. The tenures offered by most lenders range from 1 year to 25 years but vary from lender to lender. The repayment will have to be done on a regular basis through Equated Monthly Installments (EMIs). The creditworthiness of the borrower will determine the interest rate applicable to him/her and is generally fixed in addition to the base lending rate of the bank.
Types of Term Loans
There are different types of term loans and they are differentiated mainly by their lifespan. The following are the most common types of term loans:
These loans are generally available to companies that are not eligible for lines of credit. The tenure of short-term loans is usually less than 1 year, but they can extend up to 18 months.
The tenure of these loans usually ranges from 1 year to 3 years, and the repayment of the amount is done in monthly installments from the cash flow of the company.
The tenure of long-term loans ranges from 3 years to 25 years, and lenders sanction the loan amount when a company pledges its assets as collateral. The repayment of the loan can either be done on a monthly or a quarterly basis from the cash flow or the profits of the company. These loans restrict the company from taking on other financial commitments such as other debts, principals’ salaries, dividends, etc. Some lenders ask companies to set aside a certain amount of their profits for the repayment of the loan.
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Benefits of Term Loans
The following are the key benefits of term loans in India:
- Low-cost credit
- Cash-flow based financing
- Customisedproducts designed to meet diverse requirements
- Offered by leading lenders in the country
- Short-term financing with tenures up to 5 years
- Quick turnaround time and hassle-free documentation
- Flexible repayment tenures
When you apply for a term loan, your credit records will be pulled out by the lender to check your credit history which reveals your creditworthiness. Your application will be approved or declined based on your credit score and your ability to repay the loan. However, some private lenders tend to offer term loans to borrowers whose credit history is not too good. If you are rejected by conventional lenders because of your poor credit score, you can consider private lenders.
How to Apply for Term Loans
Term loans are similar to business loans. You will have to submit information regarding the business and the business owners. The following are some of the materials you will need when applying for a term loan:
- A detailed business plan explaining the need for financing, what assets are to be purchased with the help of the loan, how your business will benefit from the purchases you plan to make, etc.
- Financial statements of the business for the past 3 years including profit and loss statements and balance sheets
- A debt schedule
- The business’ tax returns for the past 3 years
- Personal financial statements of each of the business owners
- Lease for the business premises, if any
- Information regarding the assets that will be purchased including the purchase agreement or sales contract, if any
- Any other document as might be requested by the lender