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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.
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.
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.
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.
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:
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.
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.
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.
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.
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.
Business term loans are best used to finance business activities and purchases. These funding needs can take a number of forms, including:
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.
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.
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.
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.
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.
|General||OnDeck||Funding Circle||Lending Club|
|Amount||$5,000 to $2,000,000||$5,000 to $250,000||$25,000 to $500,000||$5,000 to $300,000|
|Speed||As fast as 2 days||Same day application approved||7 days||3 to 10 days from starting an application|
|Personal Credit Score||500+||500+||660+||620+|
|Time in Business||Minimum one year||Minimum of one year||Minimum of two years||Minimum of one year|
|Business Cash Flow||n/a||$100,000||n/a||$50,000|
|Cost of Funding||Interest 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 Terms||1 to 5 years||3 to 24 months||6 months to 5 years||1 to 5 years|
|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.|
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.
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.
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