Running a small business comes with its own set of financial hurdles, especially when it comes to securing funds for growth. Whether it's buying new equipment, covering everyday expenses, expanding your workspace, or handling unexpected emergencies—finding the necessary funding can be challenging. Thankfully, many banks and lenders offer term loan programs tailored to help businesses achieve capital expenditure and expansion goals.
This blog post explores what a term loan is all about the various types available, the eligibility criteria you need to meet, and the key features and benefits they provide. Let's get started!
What is a Term Loan?
Term loans are fixed-amount loans that are provided by banks or NBFCs to be repaid in regular instalments (EMIs) over a specified period.
Term loans offer both fixed and floating interest rates. Generally, for business term loans, the repayment tenure ranges from 12 months to 60 months. For other loan products, such as home loans or personal loans, the repayment tenure can be up to 10 years or more, depending on the interest rate applied and the loan amount disbursed.
Highlights of Term Loan
Some of the highlights of term loans are as follows:-
- Making regular instalment payments can help a business's credit score and overall creditworthiness.
- On the plus side, term loans can be returned early with no penalties, giving you more flexibility to pay off your obligations ahead of schedule.
- These loans are very effective for obtaining rapid funding to jumpstart new ventures or meet immediate objectives. However, they have rigorous approval processes and frequently demand main security or collateral to limit risks if you fail at maturity.
Types of Term Loans
Term loans are divided into three types: short-term, intermediate-term, and long-term. There are some other varieties of term loans as well, and the following factors are considered to determine the borrower’s funding requirements:
- Amount of loan needed
- Borrower’s repayment capacity
- Cash flow and in-hand availability of funds
Term loans are available in the following formats:
- Short-term Loans: A short-term loan is usually offered for a tenure ranging from 12 to 18 months. Some lenders consider loans of up to 5 years or 60 months as short-term loans. People who borrow short-term loans have immediate, medium-sized funding needs which can be repaid comfortably within a short time.
- Intermediate-term Loans: Generally, intermediate or mid-term loans have a loan tenure ranging from 3 to 5 years. These loans have a significant ticket size, which can be used for making big-budget funding requirements such as purchasing machinery for business, etc.
- Long-term Loans: Usually, long-term loans have tenure that can be as high as 25 years. These types of loans are usually secured and have attractive term loan interest rates and easy EMI options.
Term Loan Category
- Secured Loan: The applicant has to submit collateral to get a secured term loan from the banks or NBFCs. Collateral submitted can be assets in the form of residential/commercial properties, equipment, etc. The interest rate for a secured term loan is usually on the lower side.
- Unsecured Loan: Most financial institutions offer unsecured term loans that do not require any collateral or guarantor. As there is a risk of default associated with unsecured loans, lenders usually charge a higher interest rate to minimise the risk factor.
How Do Term Loans Work?
Term loans are the most convenient loan option compared to other financing options. They come with the fixed loan amount, interest rates, EMIs, etc., making it easy to understand how term loan works. Here’s how it works:
- Fixed Loan Amount: Terms loans have pre-determined loan amounts. The loan amount varies depending on the type of term loan you choose. The actual loan amount is determined after meeting the lender’s eligibility criteria.
- Fixed Repayment Tenure: Your repayment tenure is decided when the loan is processed. You must repay the borrowed amount in EMIs spread across the repayment tenure set for you. The duration of loan repayment can further classify your loan as a short-term, mid-term or long-term loan.
- Unsecured or Secured: Depending on your eligibility for the loan amount required and your preference, term loans are offered as both – secured and unsecured. Examples of unsecured loans are personal loans and business loans, which are given to you without collateral. Examples of secured term loans are home loans and car loans, which are offered to you against collateral.
- Fixed or Floating Interest Rate: As term loans can be offered with a fixed or floating rate of interest, you have a choice of interest rate.
- Fixed Repayment Schedule: Term loans come with a repayment schedule, and you are required to pay the borrowed amount in EMIs based on this schedule. The EMI that you pay is made up of 2 components – the principal component and the interest component. The EMI amount is based on the interest rate and the loan tenure applied to your term loan. You can find the EMI amount before applying for a term loan by using an EMI calculator.
Features of Term Loan
Term loans have numerous significant qualities.
- First and foremost, they have secured loans in which the bought asset serves as principal security and other firm assets serve as collateral.
- Regardless of a company's financial situation, payments must take place within a set time frame.
- Interest rates are decided by credit risk assessment, loan size, and duration. These rates satisfy a minimal lending threshold and are negotiated at the time the loan is originated.
- It typically matures in 5-10 years, with instalment repayments that can be adjusted during financial crises as needed.
- Lenders sometimes prohibit you from taking out new loans or require you to maintain an asset base while repaying previous ones.
- Some term loans may turn into equity under certain circumstances established by lenders, who also apply default penalties and charge commitment costs on unused sums.
- The principle is repayable after a 1-2 year grace period; commercial banks typically anticipate equal quarterly instalments, whereas financial institutions prefer semi-annual payments.
- Over time, repaying the debt gets easier as interest rates fall, but principal repayments remain constant.
Advantages of Term Loans
- Easy to Meet Eligibility Criteria and Hassle-free Documentation: With minimum eligibility criteria and just a few essential documents, you can get these loans without any hassles.
- High Amount and Low-interest Rate: With term loans, you can be eligible for a large loan offered at an interest rate lower than most credit cards.
- Flexible Loan Tenure: You have the option to choose the loan repayment tenure depending upon your repayment capacity.
- Affordable EMIs: You can choose a repayment tenure based on your repayment capacity—shorter tenure, higher EMIs; longer tenure, lower EMIs.
- Total Cost of the Loan is Known Before Applying: During the application process, you have an idea of the total cost of the loan, making it easier for you to budget your finances.
- Interest Paid is Sometimes Tax-deductible: When you use the term loans for specific purposes such as for business, to buy or construct property and to buy assets, ITA allows a deduction on the interest amount paid on the term loan.
Disadvantages of Term Loans
Term loans have some downsides as well.
- One significant difficulty is the long-term burden of monthly EMI repayments, which need careful planning and timely payments.
- In some circumstances, collateral is required, which adds another layer of obligation. Failure to satisfy these repayment commitments might raise major concerns about a company's liquidity and possibly jeopardise its existence.
- Debt financing naturally raises financial risk and reduces shareholder benefits. You may also need to handle restrictive covenants imposed by lenders, which can disrupt everyday operations by requiring loan closures or asset upkeep without taking on new loans.
- Negotiable clauses can occasionally work against the lender's interests if not appropriately handled. Furthermore, lenders have no authority over the company's actions but may advocate for debt conversion into equity under specific circumstances.
- Another danger is the depreciation of equipment funded with term loans. Extended loan durations may result in owing more than the depreciated value at resale.
- New enterprises sometimes struggle to obtain term loans owing to insufficient financial records that do not create trust in banks about their financial stability.
As a result, doing a comprehensive risk assessment before agreeing to a term loan is critical. This helps avoid potential hazards such as repossession or bankruptcy down the road.
What are the Eligibility Criteria for Term Loans?
To be eligible for a term loan, applicants must fulfil specified requirements established by banks or financial organisations.
- You must be an Indian citizen between the ages of 18 and 65.
- Furthermore, keeping a solid creditworthiness and payback history is critical.
- A credit score of at least 750 is essential to demonstrate financial responsibility.
- Also, a continuous revenue source is required to ensure timely repayment of the loan.
- Finally, you should not have any prior defaults with financial institutions since this may limit your eligibility for a term loan.
Who is Qualified to Apply for a Term Loan?
- Whether you are a paid professional wanting to fund personal initiatives or an entrepreneur starting a business, there's good news for you. Self-employed people and manufacturers are also eligible, making it simpler to grow your business operations or invest in new equipment.
- Traders and small-business owners are not left out; they, too, may profit from these loans to develop their businesses.
- Even non-governmental organisations (NGOs) requesting financing for various programs are eligible, ensuring that varied sectors receive financial assistance when needed.
How to Apply for a Term Loan?
You can apply for a term loan online or offline. For offline methods, you need to visit the branch and complete the formalities at the bank office. In the online method, you need to visit the chosen lender’s official website and fill out the online loan application form. Once the form is submitted, the bank’s representative may contact you to proceed with the formalities.
The easiest way to apply for a term loan is through MoneyTap. Visit the website or download the app, fill out the online application form, and get instant approval. Once the bank authorities do the final verification, the loan amount will be released to you.
FAQ
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What are the different forms of term loans?
Term loans come in three types: short-term, intermediate-term, and long-term.
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What are CC and term loans?
Strong financial statements and a well-established small business are frequently ideal candidates for a term loan. The credit limit for a cash credit account is often represented as a percentage of the collateralised security's value. Business clients can obtain short-term liquidity through cash credit.
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Term loans: good or bad?
Term loans are best suited for well-established businesses with a solid financial history. If you have terrible credit or no company experience, you may struggle to get accepted for a term loan. Finally, term loans are better suited for firms that do not need the money right now.
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What exactly is the EMI for a term loan?
Each term loan includes a repayment schedule that you must adhere to to make monthly EMI payments. The EMI enables you to make timely repayments since it is made up of principal and interest components that are calculated using the proper term loan interest rates.
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Which is preferable: a term loan or a flexible loan?
Typically, a lender extends a term loan for a particular time with a preset repayment schedule and an interest rate. Flexi personal loans allow you to withdraw as much as you need from your permitted loan amount as frequently as you want, whenever you need to. Your unique circumstances and requirements can be the deciding factor when choosing between these two.
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What are Hybrid term loans?
Hybrid loans are a type of personal loan that most banks do not offer. You are approved for a particular amount of money. Still, rather than receiving it all at once, you may withdraw as much as you need over a set length of time, often six months, with monthly interest-only payments.
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Which loan type, fixed or floating, is preferable?
Floating rates are slightly lower than fixed rates. Choose a fixed-rate home loan if you are satisfied with the present interest rates and are confident that they can rise in the future. If you are unsure about the path of interest rates, get a house loan with a variable rate.
