Unlocking Financial Flexibility: A Guide to Business Term Loans

Get Funded, Build Securely:

Here's your quick guide to Business Term Loans:

- Payback? Predictable & manageable: Repay in fixed monthly installments, spreading the cost.
- Collateral? Security matters: Often require collateral like assets, but not always.
- Interest rates? Know your options: Choose fixed rates for consistent costs or variable rates for potential savings.
- What are the typical credit score criteria? Lenders typically seek a mid-FICO score of 650 or above and an SBSS (Small Business Scoring System) score of 160 or higher.
- Where to find them? Explore both banks & non-bank lenders for competitive offers.

What is a Term Loan?

Imagine a term loan like borrowing money from a friend and agreeing to pay it back over a certain time, just with a bit more formality. Most of us have experienced this kind of borrowing before, like when we get a car loan or a mortgage for our home.

What's the "Term" in "Term Loan"?

The term part just means the time you have to pay back the money you borrowed. It's usually several years. So, if you borrow money for five years, you'll be making payments every month for five years to pay it back.

How are Term Loans Used in Business?

Businesses use term loans to buy stuff they need to run smoothly, like land for a new store, equipment for a bakery, or even a delivery van. The time it takes to pay back the loan depends on how long that stuff will last. So, if it's something small like a computer, you might pay it back in a few years. But if it's something big, like a building, it could take 20 years or more.

Are Term Loans Always Secured?

Sometimes, but not always. Secured just means that if you can't pay back the loan, the lender can take the stuff you bought with the loan money. But other rules can apply, too. I hope this helps you understand what a term loan is all about! If you have any questions, feel free to ask.

Breaking Down Term Loans for Merchants.

Term loans are like a financial boost for businesses. Imagine you want to buy something big for your shop, like a new oven for your bakery. But you don't have all the money right now. That's where a term loan comes in handy.

How Do Term Loans Work?

Think of it as borrowing a chunk of money from a bank or a lender. You agree to pay it back over time, usually in monthly payments. This way, you don't have to fork over all the cash upfront.

What Can You Use Term Loans For?

Term loans are great for big purchases that can help your business grow, like buying equipment or renovating your store. Maybe you need a fancy coffee machine for your café or new shelves for your store. Whatever it is, a term loan can help you get it without draining all your savings.

Why Choose a Term Loan?

Term loans give you flexibility. Instead of waiting to save up for that big purchase, you can get the money you need now and pay it back over time. Plus, you can negotiate the terms, like how much you'll pay each month and how long you'll have to pay it off.

What to Keep in Mind.

Before you jump into a term loan, make sure you understand the terms and conditions. You might have to pay interest or fees, so it's essential to know exactly what you're getting into. Overall, term loans are a smart way for businesses to invest in their future without breaking the bank. If you're thinking about making a big purchase for your business, a term loan might be just what you need to make it happen.

Understanding How Term Loan Payments Work.

When you take out a term loan, it's essential to understand how the payments work. Let's break it down in simple terms.

Amortization: Paying Off the Loan.

Each time you make a payment on your term loan, you're chipping away at what you owe. This process is called amortization. Your payment covers two things:

1. Interest: This is the cost of borrowing money. It's like paying rent on the loan amount.

2. Principal: This is the actual loan amount you borrowed. Paying down the principal reduces your overall debt.

Fees.

Before you take out a term loan, be aware of any fees involved. Some lenders charge upfront fees, while others add them to your loan balance. Ask your lender about fees during the application process, so there are no surprises later.

Protecting Your Investment.

If you're using the loan to buy assets, like equipment or property, your lender may require insurance. This protects their investment if something goes wrong. If you fail to maintain insurance or pay property taxes, your lender might cover these costs and add them to your loan balance.

Late Payments.

It's crucial to make your loan payments on time. Most term loans have penalties for late payments. These penalties can add up, so be sure to stick to your payment schedule.

Repayment Schedule.

Term loans typically have monthly payments, but some lenders offer other options, like quarterly payments. Make sure you understand your repayment schedule and budget accordingly.

Balloon Payments.

Some term loans, especially for real estate, offer long repayment periods, like 20 years. But at the end of a shorter initial term, like five to seven years, you might face a balloon payment. This means you'll need to pay off the remaining balance in one lump sum. It's essential to plan for this and be prepared to refinance or pay off the loan. Understanding how term loan payments work can help you make informed decisions about borrowing money for your business. If you have any questions, don't hesitate to ask your lender for clarification.

Examples of Term Loans in Action.

Term loans can be a lifeline for businesses facing various needs. Let's explore some real-world scenarios:

1. Restaurant Equipment Purchase: Imagine a bustling restaurant needing to upgrade its kitchen equipment, including essentials like refrigerators, ovens, dishwashers, and counters. However, the business lacks the upfront capital for such significant purchases. Worried about high credit card interest rates and accumulating debt, the owner seeks an alternative. A business term loan provides the restaurant with the necessary funds upfront, requiring only a small down payment. With this cash infusion, the restaurant can purchase the new equipment outright. Then, over several months or even years, they repay the loan through manageable monthly installments.

2. Uniform Supply Store Expansion: In another scenario, consider a uniform supply store located near a hospital that recently opened a new unit in town. With the influx of medical staff, the demand for scrubs and personal protective equipment (PPE) skyrockets. The store needs to quickly expand its inventory to meet this surge in demand. However, stocking up on additional supplies requires a substantial upfront investment that the store cannot cover from its existing cash flow. This is where a business term loan comes into play. By securing a term loan, the uniform supply store obtains the necessary capital to purchase the extra inventory without straining its cash flow. This allows the store to meet consumer demand promptly and seize the growth opportunity presented by the hospital's expansion.

In both examples, term loans serve as valuable financial tools that empower businesses to address critical needs, seize growth opportunities, and navigate challenges effectively. Whether it's investing in essential equipment or capitalizing on market demand, term loans provide businesses with the flexibility and support they need to thrive.

Advantages and Disadvantages of Term Loans.

As with any financial decision, it's essential to weigh the pros and cons of term loans before committing to one. Here's a breakdown of the benefits and potential drawbacks:

Pros:

1. Rapid Access to Funds: Term loans offer a quick and straightforward way to secure financing, allowing businesses to address immediate financial needs promptly.

2. Lower Interest Rates: Compared to credit cards, term loans typically come with lower interest rates, helping businesses save on borrowing costs over the long term.

3. Credit Improvement Opportunity: Making timely payments on a term loan can positively impact your business's credit profile, potentially improving its creditworthiness and opening doors to future financing opportunities.

Cons:

1. Credit Consequences: Failing to repay a term loan on time can have adverse effects on your business's credit score, potentially limiting its access to future financing and impacting its reputation with lenders.

2. Lengthy Approval Process: Unlike some other forms of financing, obtaining approval for a term loan can take time, requiring a thorough evaluation of your business's financial health and creditworthiness by the lender.

3. Late Payment Penalties: Missing payments on a term loan can result in penalties, including additional fees and increased interest rates, further burdening your business's financial obligations.

By carefully considering these factors, businesses can make informed decisions regarding term loans, ensuring they align with their financial goals and capabilities.

Approval Rates for Term Loans.

Securing approval for a term loan, especially from traditional banking institutions, can pose significant challenges for small businesses. A survey conducted in January 2014 revealed stark statistics regarding approval rates:

- Small businesses applying for term loans from major banks faced daunting odds, with approval rates falling below 20%.
- In contrast, businesses that sought term loans from smaller banking institutions experienced notably higher approval rates, hovering around 50%.

These findings underscore the importance of exploring diverse lending options and understanding the unique criteria and preferences of different financial institutions when seeking term loan financing.

Understanding Term Loan Interest Rates and Fees.

When obtaining a term loan, you'll encounter interest charges, which vary based on several factors:

- Index Rate: Lenders typically offer interest rates based on key indicators like the Prime Rate, LIBOR, or Treasury Rate, depending on the loan type.  
- Credit Risk: Your perceived credit risk influences the interest rate offered by the lender. Higher risk may result in higher rates.
- Loan Term: The length of the loan term also affects the interest rate. Generally, longer terms may entail higher rates.

Term loan interest rates can be classified into fixed or variable rates:

- Fixed Rates: With fixed rates, the interest remains constant throughout the loan term, providing predictability. However, fixed-rate loans often come with a premium on top of the interest.
- Variable Rates: Variable rates are tied to an interest rate index, fluctuating based on the lender's cost of capital. While initially offering lower rates, they can change over time, potentially increasing or decreasing.

For term loans spanning five to ten years, predicting the stability of variable rates is challenging. However, as you make payments and reduce the loan balance, the impact of interest rate fluctuations lessens, resulting in more predictable monthly payments.

Understanding Closing Fees for Term Loans.

When securing a business term loan, anticipate additional fees, including:
- Commitment or Loan Fee: Typically around 1% of the loan amount, this fee is paid upfront to secure the loan commitment.

- Closing Costs: These fees are based on the lender's lien on the loan collateral. For equipment loans, closing costs may be around 1% of the total amount, while for real estate loans, they can range from 1% to 7% of the total loan amount.

Benefits of Taking Out a Term Loan.

While credit cards are suitable for immediate expenses like travel or office supplies, and credit lines are ideal for managing cash flow, term loans serve a different purpose. They are intended for significant, high-cost purchases that offer long-term benefits to your company.

Here are some typical reasons why a business might seek a term loan:
1. Equipment and Machinery: Term loans can be used to finance the acquisition of essential equipment and machinery required for manufacturing, servicing, or repair operations.

2. Technology and Office Equipment: Businesses often use term loans to invest in technology upgrades and essential office equipment such as computers, phone systems, copiers, furniture, and point-of-sale (POS) systems.

3. Real Estate: Term loans provide funding for various real estate needs, including office space build-out, renovations, and new construction projects.

Sources of Term Loans.

Term loans can be obtained from various sources, including:

1. Commercial Banks: Traditional commercial banks are a common source of term loans for businesses. They offer competitive rates and terms tailored to the needs of the borrower.

2. Finance Companies: Finance companies specialize in providing loans and other financial services to businesses. They may offer term loans with flexible terms and requirements.

3. Non-Bank Lending Companies: Non-bank lenders, such as online lenders and peer-to-peer lending platforms, also provide term loans to businesses. These lenders often offer quick approval processes and may be more lenient with credit requirements.

4. Captive Finance Companies: Some equipment and vehicle manufacturers have captive finance companies that offer term-loan financing specifically for the purchase of their products. These loans may come with special incentives or benefits for customers.

5. Specialized Lenders: Certain non-bank lenders specialize in financing working capital and may also offer term loans to their clients. While these loans may be more restricted, they can still provide valuable funding options for businesses.

Applying for a Term Loan: A Step-by-Step Guide.

When applying for a term loan, it's essential to gather the necessary information and documents to streamline the process and improve your chances of approval. Here's a step-by-step guide on how to apply:

1. Gather Required Information: Prepare detailed information about your business and its owners. This may include resumes for all principals involved in the business.

2. Prepare Application Materials: Have all necessary documents ready, including:  
- A comprehensive business plan outlining your financing needs and how the loan will be used.  

- Financial statements for the past three years, including balance sheets and profit and loss statements (P&L).  
- Tax returns for the business and its owners over the past three years.  
- A debt schedule detailing existing obligations.  
- Personal financial statements for all business owners.  
- Lease agreements for business premises, if applicable.  
- Financial projections for the next three years, demonstrating the ability to repay the loan.  
- Resumes for all business owners and key employees.  
- Information about the assets to be purchased, including sales contracts or purchase agreements.

3. Check Credit Reports: The lending institution will obtain credit reports for your business and likely for you as well. Review your business's credit report before applying to understand your standing.

4. Submit Application: Submit your application along with all required documents to the lender. The turnaround time for approval may vary depending on how quickly you provide the information and the complexity of your situation.

5. Review Loan Terms: Carefully review the terms of the loan, including interest rates, repayment schedule, and any fees or penalties. Pay attention to penalties for late payments or early repayment, especially with fixed-rate financing.

6. Seek Expert Advice: If you're unsure about any aspect of the loan terms, consider seeking advice from a financial expert or lawyer. They can help you understand the terms and ensure they align with your business goals.

7. Consider Auto-Pay Options: Inquire about auto-pay options, which may offer discounts on the interest rate. Understand how these options work and whether they are beneficial for your business.

8. Finalize and Sign: Once you've reviewed the terms and are satisfied, finalize the loan agreement and sign the documents. Be sure to keep a copy for your records.

In conclusion, term loans are a valuable option for financing capital improvements, equipment purchases, real estate acquisitions, and other business needs. While they often come with favorable rates, it's essential to do your homework and carefully review the terms before signing. By following these steps and being prepared, you can navigate the loan application process with confidence and secure the funding your business needs to succeed.