The Pros and Cons of a Term Loan

What is a term loan?

A term loan is a one-time upfront payment you receive from a bank, credit union or online lender. The lender provides the funds, and you repay the loan with interest over months or years. The interest rate can be fixed or variable and tends to be lower than the rates for other types of financing.

Term loans can be used for both personal and business expenses. Many business owners apply for a term loan to fund a one-time project or as a means to achieve long-term business growth. [In need of a small business lender? Check out what we recommend as the best loan options for small businesses.]

How do term loans work?

You apply for a term loan through a bank, credit union or online lender. Banks and credit unions tend to offer the most favorable rates, but they have more stringent requirements, and their loans can be harder to qualify for.

In comparison, an online lender may have higher rates, but the application process is more straightforward, and you’ll often receive faster approval and funding. If you apply through a lending marketplace, you’ll submit your application once and receive offers from multiple lenders.

Once you’ve chosen a business lender and been approved for the loan, you must agree to the rates and repayment terms. Your rates will depend on various factors, including your personal and business credit history, cash flow, and time in business.

Business loan repayment terms typically range from three to 10 years. If you receive a fixed-rate loan, your interest rate will stay the same over the life of the loan. With a variable-interest loan, your rate will change periodically.

Types of term loans

If you decide you want a term loan, you can apply for a short-term, intermediate-term or long-term loan. You can use the funds from a term loan to expand your business operations, purchase equipment or finance a new marketing campaign. 

Term loans allow companies short on cash flow to invest in new opportunities and maximize their chances for additional revenue. The type of loan you apply for will depend on the business you run and your financing needs.

Short-term loans

Short-term loans are loans for smaller amounts with shorter repayment periods – generally one or two years.

Short-term loans are good for day-to-day working capital expenses. However, since these loans are more convenient and easier to apply for, you can expect to pay higher rates.

Intermediate-term loans

Intermediate-term loans are the happy medium between short- and long-term loans. The repayment terms are typically two to five years; you can access up to $500,000.

These loans are a good option for businesses looking to open a new location or hire more people. This type of funding can help you expand your business operations and generate more revenue.

Long-term loans

Long-term loans offer the highest amounts and the longest repayment terms. You can access millions of dollars in funding; repayment terms can be up to 25 years.

A long-term loan is a good option for an established business with excellent credit and a solid financial record. You may consider one to fund your business’s long-term growth strategies.

A Small Business Administration (SBA) loan is a good example of a long-term loan. If you apply for a standard 7(a) loan from the SBA, you could receive up to $5 million in funding. Your lender will determine your rates, but they cannot exceed the SBA’s maximum. [Related content: SBA Loans vs. Conventional Loans]

When to consider a term loan

If you’re pursuing business funding, you have many options to consider, including non-bank financing. So, how do you know if a term loan is the right choice for your business as opposed to, say, a revolving line of credit? Consider the following circumstances:

• You have a short-term project or expense. Generally, a term loan is a good choice for a short-term project or expense. For instance, if you must purchase inventory or invest in a marketing campaign, a term loan can help you cover this expense.
• Your business has an excellent financial history. Term loans are best for established businesses with proven financial track records. Qualifying for a term loan may be challenging if you have bad credit or limited business experience.
• Your business doesn’t need the money immediately. Finally, term loans are best for businesses that don’t need the money immediately. Applying for a term loan can take time, especially if you want to take advantage of the low rates at a bank or credit union. So, if you need fast access to cash, a term loan may not be your best option. [Learn about business loans versus cash advances.] 

How to apply for a term loan

Here are the steps you’ll need to take when applying for a term loan:

1. Get your paperwork in order.

It’s a good idea to get your financial records in order before applying for a term loan. The exact requirements vary by lender, but here’s an overview of the information you can expect to provide:

• Employer identification number (EIN)
• Personal and business credit history
• Business tax returns
• Bank statements (You should open a business bank account if you haven’t already.)
• Profit and loss statement
• Income statement

2. Apply with multiple lenders.

When applying for a term loan, the total cost should always be top of mind. If the interest rates are excessively high and you don’t generate much additional revenue from your investment, you could find yourself upside down on the loan. It’s a good idea to apply with several lenders so you can compare rates and repayment terms to find the most affordable loan for your business.

Many lenders will preapprove you for a loan with a soft credit inquiry, so you don’t have to worry about it hurting your credit score. You can also apply through a lending marketplace and receive multiple offers with just one application.

3. Compare your offers.

Once you’ve received offers from several lenders, evaluate each one. While choosing the lender with the highest loan amount may be tempting, you should consider a few other factors.

Pay close attention to the annual percentage rate (APR), which will help you determine how much it will cost to borrow the money. You also want to look at the repayment terms, as this will significantly impact your ability to repay the loan.

It’s also crucial to pay close attention to any fees the lender charges. If the loan has a low rate and flexible repayment terms, it’s easy to overlook the fees, but they can add thousands of dollars to the cost over the life of the loan. Here are some significant fees to watch for:

• Origination fee: An origination fee is what you’ll pay the lender upfront to process the loan. This fee ranges from 1 to 5 percent of the total loan amount.
• Prepayment penalty: If you pay off the loan early, the lender loses out on future interest payments, so some lenders charge a penalty.
• Late fee: As with most monthly costs, you’ll pay an additional fee for making your monthly payment late.
• Processing fee: A processing fee covers the cost of underwriting the loan.

4. Close on the loan.

Once you’ve chosen a lender and agreed to the loan contract terms, you’re ready to close on the loan and receive the funds. Depending on the lender, you could receive the funds within a day or two of the closing.

What are the benefits and drawbacks of term loans?

Like all financing options, term loans have pros and cons to consider before making a decision.

Pros

• Term loans can fund short-term financing needs. If you must purchase new assets or equipment for your business, a term loan can be a good option. You can take advantage of the opportunity to grow your operations, and the revenue you earn will help you repay the loan.
• Term loans tend to have lower rates. Term loans generally offer low rates and flexible repayment terms. You can repay the loan over time without it becoming too much of a financial burden for your business.
• Term loans help you build business credit. Assuming you make your monthly payments on time, a term loan can be a great way to build your small business credit.

Cons

• Term loans are relatively hard to qualify for. Since term loans have favorable rates and repayment terms, they are usually harder to qualify for than other loans. You must show an excellent credit history and provide detailed financial information to your lender.
• Some lenders will require collateral for term loans. If your lender considers your business a financial risk, it may require you to put down some type of business collateral. This is known as a secured loan or asset-based lending. If you can’t repay the loan, your personal or business assets are at risk. [Read related article: Should You Get an Unsecured Business Loan?]
• Lenders may charge additional fees for term loans. Some lenders charge additional costs for term loans, such as an origination fee. Depending on the lender, you could even get hit with a prepayment penalty if you pay off the loan ahead of schedule.

The best business lenders for term loans

If you’re convinced that a term loan is ideal for your needs, we recommend comparing options from the following business lenders:

• SBG Funding: This lender offers terms as short as six months and as long as 10 years. You won’t be required to put up collateral to secure your loan, though you may need to sign a personal guarantee. Learn more via our SBG Funding review.
• Fora Financial: Short-term loans are among Fora Financial’s specialties, with terms capped at 15 months. You won’t need to put up collateral or sign a personal guarantee, and you won’t incur a prepayment penalty for paying off your loan early. Check out our Fora Financial review to learn all about this lender.
• Noble Funding: You can obtain long-term loans, short-term bridge loans, asset-based loans and unsecured loans through Noble Funding. Loan amounts range from $75,000 to $25 million, with terms spanning four months to five years. Read our Noble Funding review to learn about this lender’s other financing options.
• BusinessLoans.com. When you apply for funding through BusinessLoans.com, you’ll be put in touch with several lenders that provide short- and long-term loans. You can also use BusinessLoans.com’s resources to learn more about term loans as you compare financing options. Explore this platform’s education-first approach to lending via our BusinessLoans.com review.

High-quality funding and predictable payments

Term loans are among the most trustworthy financing options available, and their fees and payment structures often minimally impact your expense management. Dive deep into how these loans work before comparing options, then make your decision. You’ll find the right loan for your needs sooner than later. From there, your business objectives will become that much more within reach.

Max Freedman contributed to this article.