Businesses have lots of options to secure financing, from loans to credit cards and lines of credit. There are many types of loans that offer financing in different amounts, on various terms and with diverse requirements. Business term loans are one of the most popular choices.
This guide breaks down everything you need to know about business term loans, so you can determine if this is the right type of loan for your company.Â
What Is a Business Term Loan?
A business term loan offers the lump sum of capital all upfront. The borrower pays back the amount borrowed with regular, equal payments over a predetermined loan term and a fixed interest rate. These are the most traditional types of business loans, as they offer the money quickly with a consistent repayment schedule.Â
Business term loans are often used by businesses to finance large purchases or company projects, such as:
- Hiring staff
- Paying for payroll or day-to-day operations during a slow period
- Paying for business expansion (into new products, services, locations, etc.)
- Purchasing inventory or large equipment
- Purchasing propertyÂ
- Refinancing existing business debts
Most business term loans range from one to five years. However, some exceptions, such as some SBA loans, can last up to 25 years. You can get a business term loan from a bank, credit union or an online lender.
Business term loans typically range from $5,000 to $2,000,000 in funding. On average, interest rates for these loans start at 6% and can be as high as 30%.Â
Types of Business Term Loans
Business term loans are divided into three categories, determined by the length of the repayment term:
Short-term Loans
Short-term business loans have a standard repayment length of less than a year to a maximum of 18 months. Out of all three term loan options, the short-term loan is usually the most expensive because it has the highest interest rate. Of course, the benefit of such a short loan is that your business doesn’t have debt for an extended period.Â
A short-term loan is best for smaller expenses, such as covering payroll for a few months or day-to-day operating expenses. Often, companies secure a short-term business loan from an online lender. Online lenders typically have less stringent requirements and fast approval processes.Â
Medium-term Loans
Repayment periods for medium-term business loans usually range from one to five years. These loans typically come with a better interest rate than short-term loans. A medium-term loan is often used for projects, such as purchasing new equipment.Â
You can get a medium-term business loan from an online lender or a traditional lender, such as a bank or credit union. Banks and credit unions typically have more requirements for loans and take longer to approve, but they can often offer lower interest rates than an online lender.Â
Long-term Loans
Long-term business loans are loans that have a repayment term of five years or longer. The average business term loans fall into the short- and medium-term categories, but long-term loans are also possible. SBA loans are one of the most popular long-term loans and can have repayment terms as long as 25 years.Â
Borrowers typically get long-term loans from banks or credit unions. The application requirements are the most stringent for long-term loans and the approval process is the longest, but the interest rate is often low.Â
Long-term loans are best suited for significant projects or expenses, such as refinancing debts, purchasing property or expanding the business.Â
Which Business Term Loan Length Is Right for You
The type of business term loan you get will depend on your needs and ability to repay. You don’t want to be committed to payments you can’t afford. Always choose the loan length that will allow your company to stay cash positive while making repayments on time.Â
The Pros and Cons of Business Term Loans
Ultimately, businesses have other funding options than just business term loans. You should fully evaluate all the positives and negatives of a business term loan to understand if it’s the best choice for your company.Â
The Positives
A Defined Repayment Plan
One of the main benefits of a business term loan is that you get to secure a fixed interest rate and make equal payments over the life of your loan. This consistency makes it easy to keep on top of your payments to ensure you can pay in full and on time. There are no jumps in interest or other surprises you need to worry about that could impact your monthly payment.Â
Suitable for Many Types of Business Expenses
Some types of business loans, such as equipment loans, can be very restrictive in how you use the funding. In comparison, you have the flexibility to apply for a business term loan for a wide range of projects or expenses (as listed above). Most lenders have few restrictions on how you can spend this funding.
Build Your Credit
A business term loan can help improve your business and personal credit. If you make your payments on time and in full, this positive repayment history can boost your credit score. Having a loan on your credit profile will also diversify your credit mix, which can, in turn, increase your credit score.Â
An increased credit score can work to help you with future business operations. The next time you need a loan or financial product, a healthy credit score will help you get approval faster, with better terms and a lower interest rate.Â
The Negatives
Prepayment Fees
Since business term loans tend to be on the shorter side, the lender wants to ensure they’ll earn as much interest from you as possible. One way they guarantee they’ll make the maximum amount of money from you is by discouraging early pay-off of the loan. Many business term loans have prepayment penalties written into the contract.Â
Of course, that’s not necessarily enough of a deterrent to not pay off a loan early. It’s up to you to do the math. You’ll need to run a cost-benefit analysis to see if the amount you would save in interest is more than the prepayment fee.Â
Before you sign any business term loan, check the fine print and ask about their prepayment policy. Not all lenders charge this fee. If you think prepayment is highly possible for you, consider finding a lender without this fee.Â
Costly
As we’ve mentioned, short-term business loans come with high interest rates. It’s important to take a moment to calculate the total interest you’ll pay over the life of the loan. Next, ask yourself if that cost is worth the benefits you’ll receive from getting the funding. Often, the answer is still yes because the money will keep your company afloat, allow you to expand or help you take advantage of a business opportunity.Â
It’s also worth noting that short-term loans are usually cheaper than using credit cards or lines of credit. Remember that your credit score will play a significant role in the interest rate you’ll secure. If you know you’re planning to apply for a business term loan in the future, start working to improve your credit today. It could end up saving you hundreds or thousands in interest!Â
Might Require Collateral or a Personal Guarantee
When you get a mortgage or an auto lease, those types of loans are secured by assets. If you stop making payments, your lender can take back the property or the car. In comparison, a business term loan doesn’t have an asset attached to it. As a result, lenders look for ways to reduce the loan risk, usually through collateral or a personal guarantee.Â
With collateral, you’re securing the loan with an asset you own. This could be your residential home, the business property or the business equipment. Your lender will seize these assets if your loan goes into default.Â
If you don’t have sufficient collateral, your lender may ask that you personally guarantee the loan. This means that if the business goes bankrupt or stops paying, the lender can come after you for the outstanding balance.Â
This isn’t a requirement of all lenders, and if you have strong credit, you may not need to do this at all. Still, you should be prepared that you may need to provide either collateral or a personal guarantee if you want your loan.Â
Business Term Loan Requirements
The requirements for a business term loan will depend on the lender you apply with. As stated previously, online lenders often have fewer requirements (and approve faster), but you pay for this with a higher interest rate. Comparatively, banks and credit unions are stricter with eligibility and take longer to approve, but interest rates are lower.Â
Generally speaking, business term loan lenders want to see:
- A credit score of 600 or higherÂ
- Annual revenue of $100,000 or more
- The business has been in operation for at least a year
Small business owners might be interested in applying for an SBA loan, which is backed by the U.S. Small Business Administration. The loan requirements for these loans are more forgiving. Some requirements for these loans include:
- The business be a for-profit company
- The business owner has demonstrated investing their own time and/or money into the company
- The company is physically located and operated in the United States
- The business cannot get funds from any other lender
Depending on which specific SBA loan you’re applying for, there may be additional requirements. The SBA loan application can be found online here.Â
Loans Can Help Your Business
Almost every business relies on funding at some point. Running a business can be expensive. Sometimes you need some extra capital to recover from a slow period, or you might need the money to explore a new product expansion. Whatever the reason, a loan can help your business continue to grow and succeed. However, it’s important that you choose the right loan.Â
Business term loans may come with some disadvantages, but they’re a preferred funding option for companies. As long as you understand the terms and sign up for a manageable repayment term, your loan can be the right financial decision.Â
Get Business Funding With Lendzi
Lendzi understands that applying for loans can be a complicated, timely process. That’s why we’ve partnered with over 60 lenders to offer borrowers a one-stop platform for their lending options. You simply fill out one application and we’ll choose the best lender, with the best rate, for you. Get started with a Lendzi application today.Â
About the Author
Kate Samano
Kate Samano is a copywriter and Head of Content at Lendzi. She believes in helping small businesses grow by providing access to viable financial advice.