When it comes to financing, small businesses have several options- including term loans- but you may be curious how this type of financing fits into your business plan. If you have a specific expense that needs to be prioritized, a term loan can help. In this blog, we’ll explain more about term loans and how they work.
Term Loan Defined
A term loan is a transaction between a lender and borrower where the lender provides a sum of money, and the borrower pays it back via smaller payments over a set period. To make it worth it for the lender, the borrower also pays interest on the loan amount.
A business term loan can be used to help business owners make large purchases because it spreads the impact of that cost over smaller installments. Much like a student loan helps students invest in their future, this type of funding can help small businesses purchase new equipment, move locations or open a new one, or other large purchases to increase future profits.
Though they are useful and necessary for growth, term loans do come with costs for the borrower, including:
Interest
Down payment
Origination fee
Underwriting/closing costs
Regardless of whether you are getting a business or personal term loan, you must make sure that you include these costs in your plans.
How does it work?
In most cases, loans from banks/credit unions are difficult to qualify for and require terms of several years. However, they do have better rates.
On the other hand, an online lender can get you better rates with fewer conditions, but you will pay more for it.
A long-term business loan of 3 to 10 years from a bank/credit union typically will have an interest rate of 4% to 6%, depending on a few factors: cash flow, credit history, and a few others. There are two types of loans you can get through a bank/credit union:
Secured, where you provide collateral that they can take if you don’t pay
Unsecured, where you don’t have to provide collateral
You can find short-term and long-term loans from various online lenders, but interest rates vary. Some are comparable to bank rates, but others may be twice as much or more.
A fixed-rate loan keeps the same interest rate throughout the term. A variable rate loan may end up with a higher or lower rate than what you start with. Most borrowers prefer to stick with fixed-rate loans because they can know what to expect.
In some cases, a small business may qualify for a loan through the SBA. The interest rates are really low because they are guaranteed by the federal government. However, you do not go directly to the SBA for these loans. Instead, you work with a bank or other lender to secure/repay the loan. If you meet the SBA’s requirements, consider reaching out to a lender to find out if your situation could benefit from SBA financing.
Examples of Business Term Loans
Below, we’ll go over a few examples of business term loans to help you understand them a little better.
There’s a small clothing vendor that has been fairly successful and wants to expand into a new area. Their cash flow is great, but it will take them a while to save the money to open a new location. A business term loan will allow them to open the new location, so they don’t miss out on the increased income.
A business term loan is similar to a personal loan. For example, if a moving company needs more trucks, as long as they have good credit, they can take out a loan to purchase them. Businesses may also use term loans to purchase other equipment as well.
That being said, these loans are not necessarily only for large one-off purchases. If a store needs to quickly increase inventory, a small business term loan can help.
Advantages/Disadvantages of Business Term Loans
Business term loans, like other types of financing, have advantages and disadvantages:
Advantages
Allows borrowers to cover immediate needs
Successful loan payments improve your business credit score
Interest rates are lower than with most credit cards, small loans, or payday loans
Disadvantages
Borrowers enter a long-term debt agreement, potentially with penalties for early repayment
Borrowers must wait for application approval unless working with an online lender
Where Can You Get a Business Term Loan?
Chances are the bank where you keep your money offers business term loans. This is a great place to start your search. However, if you are unlikely to be approved by a bank or you need the money quicker, an online lender may be your best option. At Ideal Financial Group, we can help you determine what is best for you and your business.