A term loan gives you a fixed amount of money upfront, which you repay over an agreed period along with interest. You usually make regular payments until the loan is fully repaid.

Term loans can be used for different needs, from business expansion and equipment purchases to certain personal financial requirements. They can also be secured or unsecured, depending on the loan and lender.

Before taking one, it helps to understand how term loans work, what affects their cost and whether the repayment fits your budget.

What is a Term Loan?

A term loan is a type of borrowing where a lender gives you a predetermined amount upfront. You then repay the amount, along with applicable interest and charges, over a fixed tenure.

Unlike a revolving credit facility, you generally receive the agreed loan amount at the beginning rather than borrowing and repaying repeatedly from an available credit limit.

The interest rate may be fixed or floating, and the loan may be secured or unsecured depending on the product and lender.

In simple terms, a term loan can be useful when you know how much you need and how long you need to repay it.

How Does a Term Loan Work?

The process is usually straightforward:

1. You decide how much you need: Start with the amount required and the purpose of the loan.

2. The lender reviews your application: The lender may assess your income, credit history, existing obligations, repayment capacity and, where applicable, collateral.

3. The loan terms are decided: These may include the sanctioned amount, interest rate, tenure, repayment frequency and applicable charges.

4. The loan is disbursed: Once the application is approved and the required formalities are completed, the loan amount is released.

5. You make regular repayments: You repay the loan according to the agreed schedule.

6. The loan is closed: Once the outstanding principal, interest and applicable charges are paid, the loan is closed as per the lender's process.

Key Features of a Term Loan

What Are the Types of Term Loans?

Term loans can be grouped in different ways. One common classification is based on the repayment period.

1. Short-Term Term Loan

A short-term term loan is repaid over a relatively shorter period. It may be useful when the borrowing requirement is temporary and you expect to repay the amount sooner.

For example: a business may use short-term borrowing to manage a temporary cash-flow requirement or purchase inventory.

2. Medium-Term Term Loan

A medium-term loan falls between short- and long-term borrowing. It may be used for requirements such as equipment purchases, upgrades or business expansion.

The repayment period gives the borrower more time than a short-term loan without committing to a very long tenure.

3. Long-Term Term Loan

A long-term term loan is repaid over a longer period and may be suitable for larger financial requirements such as property, infrastructure, major equipment or business expansion.

A longer tenure can make each repayment more manageable, but the loan may cost more in total interest because the balance remains outstanding for longer.

4. Secured and Unsecured Term Loans

Term loans can also be classified based on whether collateral is required.

• Secured term loan: The loan is backed by an asset or other acceptable security.

• Unsecured term loan: No collateral is required, so the lender may place greater importance on factors such as credit history, income and repayment capacity.

What Determines the Interest Rate on a Term Loan?

There is no single interest rate that applies to every term loan. A lender may consider factors such as:

• Your credit score and credit history

• Income and repayment capacity

• Existing loans and financial obligations

• Loan amount

• Repayment tenure

• Whether the loan is secured or unsecured

• Type and purpose of the loan

• Lender-specific risk assessment

• Market conditions, where applicable

This means two borrowers applying for similar loans may receive different interest rates.

How Does Tenure Affect a Term Loan?

The tenure you choose affects both your regular repayment and the total cost of borrowing.

1. Shorter tenure

• Higher periodic repayment

• Loan is paid off sooner

• Generally lower total interest, all else being equal

2. Longer tenure

• Lower periodic repayment

• Longer repayment commitment

• Potentially higher total interest

For example: choosing a longer tenure can make a loan easier to fit into your monthly budget, but you may pay interest for a longer period.

The right tenure is one where the repayment is manageable without unnecessarily increasing the total cost of the loan.

What Are the Advantages of a Term Loan?

1. Predictable repayment structure

You know the agreed repayment schedule and the period over which you need to repay the loan.

2. Upfront access to funds

The sanctioned amount is generally disbursed upfront, making a term loan suitable for a planned, one-time financial requirement.

3. Clear repayment timeline

You have a defined end date for the loan, provided you make repayments according to the agreed schedule.

4. Useful for planned expenses

Term loans can be suitable when you know how much you need and have a clear idea of how you will repay it.

5. Can help build credit history

Making your loan repayments on time can contribute to a positive credit history.

What Are the Disadvantages of a Term Loan?

1. You have a fixed repayment obligation

You must continue making scheduled payments even if your financial situation changes.

2. Interest adds to the borrowing cost

You repay more than the principal when interest and applicable charges are involved.

3. Early repayment may have conditions

Depending on the loan and applicable rules, prepayment or foreclosure may be subject to specific terms or charges. Always check the loan agreement before paying the loan off early.

4. Missed payments can hurt your credit profile

Late or missed payments may result in applicable charges and can negatively affect your credit history.

5. Less flexible than revolving credit

Once the agreed amount has been disbursed, you generally cannot keep drawing additional funds from the same facility unless the loan terms specifically allow it.

Who Can Apply for a Term Loan?

Eligibility depends on the type of term loan and the lender. Common factors may include:

• Age: Indian resident, aged 22 to 55 years

• Income: Minimum net monthly income of ₹25,000

• Employment or business stability: Both salaried & self-employed applicants eligible

• Credit history: Has a credit score of 650 or above

Both individuals and businesses can access term-loan products, depending on the lender and purpose of borrowing.

For individuals, a personal loan can be structured as a term loan when a lump sum is provided and repaid through scheduled instalments over an agreed period.