Term loans

A Quick Guide to Term Loans

From small business loans to business credit cards, there are many options available for entrepreneurs to finance their projects. When you have an investment opportunity that will create a steady stream of revenue, you’ll often find that a term loan provides several benefits. With term loans, a business owner borrows a lump sum from a lender, commits to make recurring payments and agrees to pay the money back over a set period of time (or “term”).

What are some common uses of term loans?

  • Hiring additional employees to meet the high demand of your startup’s goods or services
  • Investing in new technology to increase your output capacity
  • Opening a second brick-and-mortar location
  • Covering working capital needs during peak seasons
  • Refinancing high-interest debt from business credit cards

Term loans aren’t meant to cover expenses that you can cover within a couple weeks, or that won’t help you boost your startup’s bottom line.

How can a term loan benefit your business?

Term loans provide flexibility because you can negotiate the term, amount and interest rate before the loan is granted. Term loans are accompanied by higher borrowing limits (up to $1 million) and lengthier repayment terms (sometimes up to 10 years). Due to their longer durations, term loans tend to be available at lower interest rates than shorter-term loans.

Term loans offer fixed interest rates, which can provide costs savings in a rising interest rate market. Given that the Fed raised its benchmark rate in March 2017 to a range of 0.75 percent to 1.00 percent (and additional raises are expected throughout 2017 and beyond), choosing a fixed interest rate term loan could save you on interest payments over time. According to Nerdwallet, most major issuers of credit cards increased the APR by 0.25 percent within a month from the Fed’s rate hike in December 2015.

Set payment plans can help with budgeting. Whether it’s a constant or increasing payment amount, having a predetermined recurring charge allows you to budget with more confidence and forces you to pay down your debt (which in turn, can help boost your credit score).

Related: How to Choose the Right Small Business Loan

Are there any potential cons with term loans?

While you can find shorter-term loans, keep in mind that they come with higher interest rates than longer-term loans and often require a more aggressive repayment schedule with larger, often daily installments.

Term loan lenders tend to have higher credit standards. If you have poor credit, this will not only likely increase your interest rates, but potentially hinder your ability to get approved for a term loan. Additionally, lenders require a demonstrated history of profitability in order to assess your qualifications for a loan (usually around two years’ worth of financial history), which means businesses just getting started are not eligible.

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How can you compare term loans against other loans?

In addition to an interest rate, lenders of term loans can charge additional fees, such as origination, documentation or processing fees. While having the full schedule of applicable fees is important, a term loan’s APR (annual percentage rate) is the true measure to evaluate a term loan against another term loan, or an alternative form of financing. Required to be disclosed by lenders by law, an APR takes all fees into consideration.

Choosing the right type of financing to help your business grow can be difficult, but you can make the process less stressful by doing your homework first. When evaluating your offer(s), pay attention to the fine print to confirm if taking out a loan—be it a merchant cash advance or term loan—is the right choice for you.

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