There are several financing options out there for small business owners, but term loans are one of the most popular loan options for borrowers. The popularity of term loans can be attributed to their ability to satisfy a number of business needs in a predictable fashion. So, how exactly do term loans work?
A term loan, which can be offered by traditional banks or online lenders, provides the borrower with a lump sum to be repaid on a set schedule at a variable or fixed interest rate. Like with other loan products, the lender can choose to add an origination fee on top of the loan amount.
Unlike other types of loans, term loans offer some of the lowest interest rates, making them an attractive option for those who can qualify – and navigate the application process.
How Can Business Term Loans Help Small Business Owners?
The length of a term loan can be anywhere from 1 year to 25+ years, allowing them to help borrowers meet short and long-term business objectives alike. Let’s look at some of the areas of business development that should sometimes, but not always be addressed with term loans.
Buy Expensive Equipment or Real Estate
Terms loan shine as a long-term financing option for small business owners. So, using a term loan to fund a purchase that is going to be a massive benefit to your business over the next 20+ years – such as expensive equipment or real estate – could be in your best interest.
But be careful. If, for example, that expensive equipment is only going to last for five years or so, you don’t want to make your last 15+ years of monthly payments while it’s in the junkyard. Look to limit the length of your term loan to the length of the useful life of your equipment – or real estate, for that matter.
Also, you want to carefully consider the impact of the monthly payments on your business with these long-term loans. If you’re taking out a 20-year loan, for example, that’s 240 months of payments.
Next, we have inventory, where, again, you should carefully consider how long it’s going to last. If you’re going to sell all of the inventory within two years, you don’t want to get a 5-10-year term loan.
That said, there are several businesses that are rapidly expanding and need the upfront cash to purchase enough inventory to keep up. If your business fits into this category and you can find a loan length that makes sense, then using a term loan for inventory purchases may be the right decision for your small business.
Hire or Keep Staff
With the pandemic still impacting millions of businesses, small business owners can turn to lenders to get the funds needed to meet payroll obligations. While Small Business Administration (SBA) loan programs may be your first choice in such a scenario, the funding is limited on these types of loans. If you’ve been shut out of SBA loans, a bank loan can prevent you from laying off your staff during difficult times.
If, on the other hand, you want to fund a business expansion, you may need to hire staff. As with inventory purchases, look for a loan length that makes sense.
Too many small business owners are drowning in high interest rate debt because they previously used business credit cards or were unable to get loans with attractive terms due to bad credit history. For small business owners who have rehabilitated their credit scores, a term loan is an excellent way to roll higher-interest rate debt into a lower monthly payment with a fixed interest rate.
With interest rates still near record lows, you may be able to refinance your old debt at lower rates. This loan option makes sense for many borrowers, but not every borrower. So, how do you know if this makes sense for you?
When you refinance, you have to pay a substantial amount of fees. If you only have a few months left of payments, the costs of refinancing would likely exceed any savings in monthly payments. But for borrowers with several years left of their term loans, the monthly payment savings may exceed the refinancing fees.
Improve Cash Flow
If your business has struggled to meet working capital requirements for a short period of time, you may be tempted to take out a term loan. By getting upfront cash, you figure your working capital woes will become a thing of the past.
But in this case, you may not want to take out a term loan. Since these tend to be long-term business loans and cash flow issues tend to be shorter term, you would likely be better off taking out a business line of credit or 3-6-month loan. Of course, if you have unique circumstances – say you have a startup that won’t be profitable for years – a term loan could be your best financing option to solve cash flow problems.
Consider Your Specific Needs
We have explored a number of possible uses for term loans, but there are many more. You may have specific needs that haven’t been addressed. What’s important is to use a solid framework to find the right small business financing option. Remember to:
- Ensure that the expected useful life of your purchase doesn’t exceed the length of your term loan.
- Carefully consider the long-term impact of the monthly payments, particularly with 10-20+ year term loans.
- See if other loan programs can do a better job of meeting your business needs.
By keeping these key points in mind, you can navigate the term loan landscape with confidence.
Pros and Cons of Term Loans for Small Business Owners
While term loans are one of the best small business financing options, they aren’t the be-all and end-all. Let’s look at some of the pros and cons.
Pros of Term Loans
Here are some of the advantages of taking out of term loan:
- Funding for large investments: With a small business loan, you can get up to $250,000 in funding to take your business to the next level. The long-term nature of these types of loans gives borrowers the ability to think strategically instead of focusing on making it to the next month.
- Lower interest rates: Term loans are typically available at lower interest rates than other small business financing options. With business credit cards, for example, borrowers can be stuck paying sky-high annual percentage rates (APRs) for years.
- Easy to budget: With set repayment terms, small business owners can easily factor their future monthly payments into their long-term budgets. While some term loans carry a variable interest rate, making it more of a challenge to make those projections, small business owners can still make reasonable predictions based on how the interest rate will be calculated.
- Get tax benefits: When your accountant files your tax return, you’ll be pleased to find out that the interest on your term loan is tax deductible.
- Keep your equity: In certain cases, selling equity could be your best option. But funding your business expansion with debt is often a better choice. That’s because debt financing lets you keep ownership and control of your business.
- Possible to get fast approval: Term loans traditionally took months to get approved. Applicants would walk into a bank, fill out mountains of paperwork, and wait… and wait. But times have changed. These days, you can apply for a term loan and the funds can hit your bank account in 72 hours.
Cons of Term Loans
With term loans, there are also disadvantages to be aware of:
- Possibility of slow approval: Yes, this one can go both ways. An online lending platform can help you get fast approval for a term loan – more on that in a bit – but if you choose to apply directly through certain banks, you could face a months-long application process.
- Minimum loan amounts: With this type of loan, you may need to borrow a minimum of $25,000. So, if you only need a few thousand dollars, you may have to turn to a different financing option.
- Need higher credit: In order to qualify for a low interest rate term loan, lenders are going to want to see a strong credit score. If your credit score isn’t high enough, you aren’t completely out of luck. There are business loan options for those with lower credit scores.
- Profitable history: Lenders want to see that your business has a history of profitability; from their perspective, this increases the likelihood that they will get their money back. If you are just getting started, a personal guarantee might work in lieu of a profitable history. But don’t take the idea of a personal guarantee lightly; it puts your personal assets at risk in the event of a business bankruptcy.
The risk/reward of getting a term loan is an individual decision. But what are the next steps if the pros outweigh the cons?
How Can a Small Business Owner Obtain a Term Loan?
If you’re ready to apply for a term loan, you could walk into a bank and start filling out an application. But if you do that, it might be months before you complete the entire process – from application to funding.
A better option is to apply through an online lender, such as Biz2Credit.
With Biz2Credit, you can talk to a funding specialist to figure out what type of loan is best for your business. Once you’ve decided on the loan terms, you can create your profile and submit your application in 5 minutes. You can get approval in as little as 24 hours and funding within 72 hours.