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Business Term Loans: A Guide to Understanding the Essentials

Unless a business owner is independently wealthy, chances are that at some point they’ll need to borrow money. A term loan offers a way for a business to access the capital it needs to reach its goals.

So, what is a term loan? In this article, we explore everything you need to know about this useful business funding method.

What Is a Term Loan?

Anyone who’s taken out a loan to purchase a car, go to school or buy a home has experience with a term loan, which is an installment loan that’s repaid over a set period of time through equal payments. Term lending provides an infusion of money into a business that can be used for a number of purposes.

For a small business term loans are the traditional method of obtaining financing that’s needed for a year or more. Classified as business loans on the borrower’s balance sheet, term loans are offered by credit unions, online lenders and traditional banks.

The requirements, rates and speed of obtaining term loan financing can vary widely from one lender to another. Before applying, it’s good to know the answers to some common questions that can help you decide if a term loan is the right funding option for your business needs.

How Much Funding Can a Business Get?

Depending upon the financial institution being used, a business can use a term loan to borrow anywhere from $5,000 to $2,000,000 at an annual percentage rate of 6% or higher.

How Fast Can the Money Be Received?

Many lenders can have the money from a loan deposited into the borrower’s account within 48 hours of approval. Online lenders can speed up this process and often provide some of the fastest turn-around times from application to funding.

What Documentation Is Needed to Get Funding?

All lenders require some forms of documentation to get a term loan. Traditional banks generally have a longer application process with more detailed documentation requirements.

Online lenders such as Lending Club, Funding Circle and OnDeck have applications that are faster to complete. However, they’ll still require documentation.

The documents lenders commonly require for a term loan application include:

  • A driver’s license
  • A voided business check
  • Bank statements for the business
  • A balance sheet
  • Profit and loss statements
  • The principal borrower’s credit score
  • Tax returns for the business and the primary borrower

While not every lender requires all of the above, it’s good practice to have these important business records on hand at all times. Be sure to submit copies whenever possible and save the originals for your records.

What Should a Credit Profile Look Like?

Each lender has specific requirements they expect to find in a business borrower’s credit profile. Most lenders consider the amount of time a business has been in operation, the cash flow of that business and the credit history of the person named on the loan application.

  • Time in business: Companies with less than one year in operation will be hard-pressed to secure a business term loan.
  • Business cash flow: This is the amount of cash that comes into a business through sales of goods or services and goes out for expenses such as wages, inventory, advertising and taxes. In other words, it’s the the amount of money generated and used during a specific period of time.
  • Personal credit score: Most lenders want to see a minimum credit score of 500 before considering approving a loan. However, some go as high as 700.

How Much Will It Cost to Get a Term Loan?

The main cost of a term loan is the interest charged, and the rate varies depending upon a business’s credit profile. With term loans, the interest rate can range between 6% and 30%.

Another cost associated with term loans is an origination fee. This fee is paid to the lender to cover costs for processing the loan application and depositing the funds. Not all lenders charge origination fees.

Some term loans may also have a prepayment penalty, which is charged for paying off the loan balance before the due date. This reduces the amount of interest the lender can collect, so they charge this penalty to make up for some of that lost profit.

What Does Loan Term Mean?

The loan term is the amount of time a borrower has to repay a loan. With business term loans, this time frame is usually between one and five years. The length of repayment is something a lender and borrower can negotiate prior to a loan being funded.

Who Qualifies for a Term Loan?

Lots of businesses can qualify for term loans. Some lenders exclude businesses considered high-risk, such as restaurants, nonprofits and those in the cannabis and adult entertainment industries. However, with careful research, a lender can usually be found for nearly any legitimate business that meets the requirements detailed above.

When Should a Term Loan Be Used?

Business term loans are best used to finance business activities and purchases. These funding needs can take a number of forms, including:

  • Increasing working capital
  • Meeting tax or payroll obligations
  • Paying for inventory or equipment
  • Refinancing existing business debts

The majority of business term loan lenders don’t put a lot of restrictions on the use of the borrowed funds. However, the main purpose of any sort of business loan should be to generate more revenue.

While it’s not advisable to take out a loan if a company is in dire financial straits, business term loans can be used in a variety of ways to help a company grow, such as funding daily operations, taking a business to the next level and covering large business purchases.

Funding Daily Operations

The most common reason for taking out a business term loan is to help fund daily operations. For example, payroll may need some additional cash until the busy season rolls around. Or, inventory may need a boost to ensure there’s ample product on hand for a grand opening sales event. Whatever the need, a business term loan can bolster the company coffers.

Taking the Business to the Next Level

Increasing the working capital of a company can be the difference between losing an opportunity and landing that major account that elevates a business to the next level. The launch of a new product line can help a business expand its customer base and increase its future earning potential. Business term loans can help fuel that growth by providing funding for research, development and marketing.

Covering Large Purchases

A major purchase can eat up a business’s available capital. By borrowing the funds instead, a company can finance a major purchase such as new technology or updated equipment without draining the business bank account.

Breaking Down Each Term Loan Payment

Business term loans follow an amortization schedule much like car loans and mortgages. This means that at the beginning of the loan, a larger portion of each payment goes toward interest and a smaller portion toward principal. As the loan matures, this gradually reverses until the majority of each payment is going toward the remaining principal.

This is done primarily as a safeguard for the lender against an early payoff of the loan. By collecting interest early and leaving the principal until later, most of the interest is already collected if the borrower pays off the loan balance before the end of the term. While the monthly payment on the loan stays the same throughout the term, a company can save more interest by paying off a loan sooner rather than later.

To understand what’s being paid and when, borrowers should always ask their lender for a loan amortization schedule.

Comparing Term Loans

GeneralOnDeckFunding CircleLending Club
Amount$5,000 to $2,000,000$5,000 to $250,000$25,000 to $500,000$5,000 to $300,000
SpeedAs fast as 2 daysSame day application approved7 days3 to 10 days from starting an application
Required DocsDriver’s license Voided business check Bank statements Balance sheet Profit & Loss Statement Credit Score Business Tax Returns Personal Tax ReturnsThree months of business bank statements Voided business check Copy of driver’s licenseSix months of business bank statements Two most recent business tax returns Most recent personal tax returnThree months of business bank statements Most recent business tax return
Personal Credit Score500+500+660+620+
Time in BusinessMinimum one yearMinimum of one yearMinimum of two yearsMinimum of one year
Business Cash Flown/a$100,000n/a$50,000
Cost of FundingInterest rate: 7% to 30%Interest rate: 8.5% to 79%Origination fee of 5.99% Interest Rate: 4.99% to 27.04%Interest rate: 5.9% to 25.9%
Payback Terms1 to 5 years3 to 24 months6 months to 5 years1 to 5 years
Collateral Requiredn/an/an/an/a
Personal Guaranteen/an/an/an/a
ProsSet payment structure Suitable for a wide range of business purposes Lower monthly payments than short-term loans Longer payment terms than short-term loansFast funding Prepayment discountMost affordable business loans online No prepayment penaltyNo prepayment penalty Quick underwriting process Small documentation list Low interest rates
ConsPotential prepayment penaltiesExpensive for lower qualified borrowers Requires daily or weekly paymentsWill not help raise credit score Better interest rates available through bank or SBA loans Will not work with startups Large origination feeOnly works with businesses with less than $20,000 in liens
Best for…Companies that are looking to buy specific inventory or equipment, that want more working capital, need to refinance existing debt, and/or are looking to meet payroll or tax obligations.Borrowers in need of fast access that have large unexpected expenses.Businesses with good credit that are looking to consolidate debt.Businesses that are trying to build business credit and those that need a quick loan.
Ineligible Industriesn/aTrue nonprofits Construction Guns Brokerage firms Law offices Financial servicesAdult entertainment Guns and ammunition Speculative (such as real estate development) Investment management Investment banking Payment processors Business & mortgage brokers NonprofitsCannabis sales Moneylenders Businesses that directly invest in the market as their primary source of revenue Businesses in Maine, Rhode Island, Idaho, and Iowa

In Summary

Business term loans are really quite simple and precise. A business borrows a certain amount for a specific period of time and repays it in set amounts at regular intervals.

Banks are the traditional lenders for term loan products. They offer lower term loan interest rates but take longer to fund and generally have stricter requirements, such as a higher annual revenue and personal credit score. Repayment terms from banks are typically up to 10 years.

Online lenders that offer term loans generally have less rigid qualifications than banks. They offer convenience and faster funding but typically cost more than bank loans in the end. Moreover, online lenders offer short-term loans with repayment terms between three months and three years in length.

Small Business Administration (SBA) loans are another option. They’re guaranteed by the federal government and available through both online lenders and banks. This kind of term loan can provide as much as $5 million for as long as 25 years, depending on how the money will be used. SBA loans have some of the lowest APRs available.

Start Now

With all these resources available to provide funding to businesses, choosing a provider for your term loan is all about the research and paperwork. Lendzi’s transparent business term loan rates and simple process makes securing your loan as easy as applying now.

Pros & Cons of Business Term Loans

Prons
  • The ability to borrow large amounts of money
  • Suitable for a wide range of business purposes
  • Few restrictions on usage
  • Relatively long payment terms can make big investments more affordable
  • Repaying term loans on time may help you build business credit
Cons
  • In spite of the benefits, there are some downsides to choosing a new business line of credit, like:
  • Potential for prepayment penalties
  • Sometimes a lengthy application process
  • Variable interest rates may increase
  • Payments begin immediately after funding
  • Collateral such as an asset may be required

Suggested Resources

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