What is Term Loan?
What is Term Loan?
Term loans are short-term loans offered to businesses for capital expenditure and expansion among others. Generally having a tenor up to 84 months, these loans are tailor-made to suit the various financial needs of businesses. Minimal documentation, quick disbursal of funds, and repayment flexibility are some of the major benefits of these loans.
a) Types of Term Loan
Term loans are available in several varieties to suit a borrower’s funding requirements based on factors like
- Amount of funding required
- Repayment capacity of the borrower
- Regular cash flow and in-hand availability of funds
Based on these, the term loan interest rates also vary along with other terms of lending. As per the term loan meaning, these advances are available in the following variants.
- Short-term loans
A short-term loan is a type of advance offered for a duration ranging between 12 to 18 months. Some lenders, however, also consider advances of up to 5 years or 84 months as short-term loans. Borrowers usually avail these loans to meet their immediate, medium-sized funding needs that they can repay easily within a short span.
- Intermediate-term loans
Financial institutions generally classify intermediate or mid-term loans as the ones that come with a tenor up to 84 months. Available in considerable ticket size, these advances sufficiently make for big-budget funding needs of businesses like purchasing machinery purchase, boosting the working capital, etc. Affordable EMIs of these loans allow businesses to repay the loan from regular cash flow.
- Long-term loans
Available at attractive term loan interest rates, long-term loans come with an extended tenor that can reach up to 84 months. The easy EMI option makes these advances convenient to repay over the long tenor while fulfilling a business’s requirement for lump-sum funding. Usually, such loans are secured in nature.
b) How does Term Loan Works?
Among multiple financing options available, term loans are one of the most convenient ones to avail as they come with pre-determined loan value, interest rates, EMIs, etc. Falling under a single line of credit makes it easy to understand the term loan process.
Below is explained how a term loan works for an easy understanding of their functioning.
- Fixed loan amount
Terms loans come with a fixed amount. Depending on the type of term loan chosen, the loan value may vary. Meeting the lender’s eligibility criteria is also essential in determining the actual loan amount.
- The fixed tenor of repayment
You must repay the amount availed in EMIs throughout a fixed tenor as determined during availing the loan. Depending on the duration of loan repayment, it is classified as a short, mid, or long-term loan.
- Mayor may not require collateral
Depending on the loan amount required, borrower’s eligibility, and choice, term loans are available as both, secured and unsecured credits. While personal loans, business loans, etc. are unsecured forms of term loans, advances like home loans qualify as secured term loans sanctioned against collateral.
- Fixed or floating interest rate
Term loans are available at both fixed and floating rates of interest. It is up to the borrower to decide which type of interest to opt for.
- Fixed repayment schedule
Every term loan comes with a repayment schedule and a borrower is required to pay EMIs based on this schedule. The EMI comprises both principal component and interest component calculated as per the term loan interest rates applicable, thus enabling borrowers to repay easily. You can determine the EMI amount before availing of the loan using an online EMI calculator.
c) Advantages & Disadvantages of Term Loans
Term loans are a suitable option for external financing to meet big-ticket funding requirements, and they come with several other advantages.
- Advantages of term loans
- The flexibility of tenor - With an option to choose a suitable tenor for loan repayment, borrowers can select a suitable term that allows them to pay EMIs as per their repayment capacity.
- Ease of repayment through affordable EMIs - Select a repayment tenor as per your income and keep your EMIs affordable.
- Minimum eligibility requirements and hassle-free documentation – You can easily avail these loans against minimum eligibility and submissions of a few basic documents, which makes the process hassle-free.
- Cost of loan limited –You can have an idea of the total cost of the loan you are required to pay during the application process itself. It makes budgeting your finances easier.
- Disadvantages of term loans
Although term loans are among the best sources of external credit, they must be cautiously used to avoid landing in a detrimental financial circumstance. To do so, borrowers must –
- Keep a track of due dates for EMI payment
- Pay EMIs in time
- Make optimum use of the loan amount
d) Example of Term Loan
A term loan is a type of advance that comes with a fixed duration for repayment, a fixed amount as a loan, a repayment schedule as well as a pre-determined interest rate. A borrower can opt for a fixed or floating rate of interest for repayment of the advance. While in the former, the rate of interest remains fixed throughout the entire tenor, the latter attracts interest at variable rates based on changes in market trends.
A business or an individual with a sound financial background can negotiate to avail a term loan at the most attractive interest rate along with other features for long-term benefits.
Below is an example to help you clearly understand the working of a term loan.
A businessman requires a sum of Rs.45 lakh to fund the purchase of equipment and machinery for the company’s efficient running. He applies for the loan and furnishes the required document. However, after evaluation, the lender finds that he is eligible for a loan of up to Rs.45 lakh only.
The financial institution thus offers the terms of the loan along with the applicable interest rate. The tenor decided was up to 84 months. The repayment schedule would thus be –
No. of EMIs = 7x12 months = 84.
The borrower is thus required to repay the loan with full and final settlement in 84 EMIs. The amount of EMI depends on the interest rate applicable and the amortization schedule followed by the lender. If money is available in a lump sum amount, the borrower can also opt for part-prepayment or foreclosure of the loan amount at any time before the end of the tenor.