June 10, 2021 | Last Updated on: February 21, 2023
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.
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.
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.
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.
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.
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:
By keeping these key points in mind, you can navigate the term loan landscape with confidence.
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.
Here are some of the advantages of taking out of term loan:
With term loans, there are also disadvantages to be aware of:
The risk/reward of getting a term loan is an individual decision. But what are the next steps if the pros outweigh the cons?
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 funding provider, 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.
