Term Loan Definition
Term loans are short-term, up-front funding options for local and small enterprises with a long repayment period. These are long-term debts issued by businesses, with a payment plan and interest paid in instalments at set or fluctuating rates. These loans, on the other hand, are not given to enterprises that do not have solid financial statements and a track record of creditworthiness.
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Term Loan Meaning – In Detail
- Term loans are advantageous due to the length of time required to repay the loan plus interest. Short-term loans require the borrower to repay the principal in less than a year, whereas term loans give them more time to organise cash and pay in instalments. Term loans are frequently used to finance the purchase of fixed assets such as machinery or buildings, as well as the initiation of projects that require a large sum of money and a long period of time to reap the benefits of such investments. Term loans help with this.
- Term loans can be taken out for a year or for a period of up to 25 years. It helps firms avoid cash shortages. They have secured loans, and assets are frequently used as security or collateral towards payment in order to ensure that payments are made on time. Many businesses prefer these loans since they do not dilute administration as much as bonds, equity, or debt finance do.
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Highlights Of Term Loan Definition
- There are three types of term loans: short term, intermediary term, and long term.
- Payments made on time and instalments improve a company’s credit score and creditworthiness.
- Term loans are useful for obtaining fast funds while starting a new project or striving to meet a specific deadline.
- They do, however, require stringent permission and appropriate main security (typically the new project itself) or collateral security to absolve defaulting on the payment on maturity, so reducing the risk.
- Term loans, on the other hand, can be paid off ahead of time with no penalties.
Term Loan Definition & Category:
Secured Loan: If an individual wants to take out a secured loan from a bank or an NBFC, he or she must provide collateral security to the borrower. Equipment, machinery, stock, raw materials, and residential/commercial properties can all be used as collateral.
Unsecured Loan: Most financial institutions offer unsecured business loans, which do not need any collateral or security to be provided to the lender. Because there is no danger to the borrower in taking out an unsecured loan, the interest rates given by banks and NBFCs are on the higher side.
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Term Loan Definition & Examples In Regards With Business Loan
Working Capital Loan: Working capital loans are used by businesses who want immediate funds to maintain cash flow or fulfil day-to-day business expenses. Working capital loans are short-term loans that must be repaid within 12 months of the date of disbursement.
Overdraft: An overdraft is a type of loan in which a banking firm gives you a credit limit based on your needs, and you pay interest only on the amount you use, not on the entire withdrawal limit. The repayment period can be as short as one month or as long as twelve months. The borrower must renew the limit with the lender once a year.
Equipment Financing: Businesses and enterprises could use this sort of loan to finance equipment or vehicles for a variety of activities, including agriculture, farming, commercial transportation, construction, and so on. The amount of an equipment finance loan will range from Rs. 1 lakh to Rs. 10 crores. The rate of interest on a term loan is determined by the individual’s profile and the type of their business.
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Top Advantages & Disadvantages Of Term Loan Or Term Financing
| Pros | Cons |
| Lower Interest Rates | Long-term burden of loan & EMIs on the borrower |
| Higher Loan Amount | Requires a high CIBIL/credit score required |
| 59 minutes to approve the loan | Guarantor is mandatory |
| Longer Repayment Timeline | High business volume and vintage |
| Quick disbursement of loan funds | Good business stability with profitability |
| No Collateral Required for Unsecured Business Loans | Collateral required – Term loans are usually unsecured |
| Interest paid is tax-deductible | Non-repayment of loan/EMI result in high penalty |
Interest Rates on Term Loans
The interest rates on term loans granted to candidates vary from bank to bank and are largely determined by the applicant’s profile and company needs. A good credit score (CIBIL) is also important for acquiring term loans with lower interest rates. In comparison to NBFCs or other lending institutions, banks provide cheaper interest rates on term loans.
FAQs
Q1) What type of loan is a term loan?
A term loan gives borrowers a lump sum of upfront cash in exchange for specific borrowing terms. Borrowers agree to pay their lenders a fixed amount over a set period of time, with either a fixed or floating interest rate.
Q2) What is the difference between a loan and a term loan?
A term loan is typically extended by a lender for a set period of time with a predetermined repayment schedule and a fixed interest rate. Flexible personal loans give you the freedom to withdraw the amount you need from your approved loan limit as often as you want and whenever you need it.
Q3) What are the advantages of a term loan?
Term loans have lower interest rates than short-term loans since they are available for a longer period of time. Furthermore, the interest rates are fixed and do not change over the life of the loan. Term loans provide a lot of flexibility.
Q4) How does a term loan work?
A term loan is a monetary loan that is typically repaid in regular instalments over a specified time period. Term loans typically last one to ten years, but can last up to 30 years in some cases. A term loan typically has an unfixed (also known as floating) interest rate that adds to the amount owed.
Q5) Which are the disadvantages of a term loan?
The disadvantage of a term loan is that the company is required by law to pay the fixed interest and principal amount to the lenders, failure to which could result in bankruptcy. Debt financing, particularly term loans, increases the firm’s financial leverage, which raises the firm’s cost of equity.
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