A loan is obtained from a bank for a specific amount that has a specified repayment schedule with either a fixed or floating interest rate. An established small business with sound financial statements is appropriate for getting these types of loans. Obtaining this loan may require a significant down payment to reduce the payment amounts and the total cost of the loan.
Once a term loan is obtained, then each payment is made to cover the interest as well as a portion of the principal amount.
A term loan also comes with preset fees that one has to pay. One has the option to either pay these fees upfront or he may add them to the total loan balance. A proper consultation with the lender is required during the application process for the loan in order to find out the best way for managing the fee amount.
An important demand the lender may ask for when this term loan is obtained is that to secure insurance on the collateral.
If the person is unable to pay the insurance payments on the assets, the lender can advance more money so that to protect the collateral. The drawback here is that the lender will then add such advances into the loan amount and charge additional interest. This causes an increase in the loan amount.
The repayment schedule for a term loan requires to make each payment on a specific date, any delay in repayment will result in a penalty.
In rare cases, a lender gives a term loan for an extended period and may ask for a short term repayment schedule. For instance, a lender lending a 25-year term loan may decide a five-year repayment schedule.
During the five years, the interest amount will be required to pay in full. However, once the 5-year term expires, one has to repay the principal amount in full which is called a balloon payment.
The following are the three types of term loans.
Short Term Loans
- It is often needed to meet the day-to-day business expenses or the working capital requirements of a business.
- Weekly repayment of loans may be possible if the term of the loan is very short.
- Sources for obtaining short-term loans include a loan from a commercial bank, trade credit, discounting bills of exchange, etc.
- It is usually for 1 to 2 years.
- It has a higher interest rate as compared to the long-term loan.
- Mostly medium-term loan is neglected as people go straight forward to the long-term loan after considering the short-term loan. A duration of 2 to 5 years is usually kept under medium-term as terms and conditions. As compared to a long-term loan, this loan is a bit different in the way that the rate of interest is comparatively higher, while the documentation part is also easier.
- Medium-term loans are often obtained for the purpose of repair or renovation of the fixed assets.
- This loan can be considered as a hybrid of short and long-term loans.
Long Term Loans
- This term loan also comes with some relaxation in terms of payment options. Like, a person may choose a fixed interest loan, where the rate is the same over the term of the loan, or an adjustable rate, where the rate is going to be changed every year. There is also an interest-only loan, where the borrower is required to pay only the interest for a set period, and then start paying the principal amount.
- This loan is usually for more than 5 years.
- A long-term loan is credit-based which means the better the credit score is, the better are the chances of getting a lower interest rate. The amount of loan a person can get will also depend on his credit history and income.
- Most of these term loans are secured, for instance, home loans, car loans, loans against property, and since the loan is secured, the rate of interest is also less.
- However, the loan can be unsecured as well. Under an unsecured loan, no collateral or asset is required, but the rate of interest is kept higher as the lender bears more risk.
In order to apply for a term loan, an applicant is required to visit the official website of the desired financial institution from whom he seeks a loan and has to fill in the loan application form online. The bank’s representative will contact the applicant and proceed with the bank formalities after the submission of the form.