Traditional term loans involve borrowing capital & repaying over a fixed period of time with interest.
At a Glance
Traditional term loans are installment loans that small businesses can use to help achieve various goals. Whether it’s a major equipment purchase or an expansion project, getting that extra infusion of working capital is something that many businesses could use at some point during their life cycle.
There are a few different types of term loans available to small business owners.
Besides traditional financial institutions like banks, this common loan product is available through alternative lenders and even the Small Business Administration.
They aren’t actually originated by the SBA, but instead are backed by the government, making them a popular choice for small businesses and lenders alike.
With a term loan, your lender sends you a deposit of the approved funding amount.
According to the Small Business Administration, the average size loan from a bank for a small business ranges between $130,000 and $140,000 but the exact amount you qualify for depends on your own company’s financial condition and business needs.
If you're approved and receive your funds, you might begin making payments to your lender on either a monthly or weekly basis.
Payments can include both the principal amount you borrowed as well as interest.
Example of a Term Loan
While many of the aspects regarding the different types of loans may vary from lender to lender, here's an example of what you might expect when you seek out a term loan.
Similar to an installment loan for your average consumer, after submitting your request with the required paperwork, the lender will let you know to what terms you were approved for. You could receive from $25,000 up to $500,000, with an interest rate sitting between 7% up to 30%. The repayment period can vary from 1 to 5 years, and you can be approved in as little as 2 days, depending on your particular case.
Typically, these funds are usually meant for one-time costs for your business, like expanding or unexpected repairs. If you have issues with cash flow, they can offer a quick solution, but won't help you in the longterm.
Secured vs. Unsecured
Something to look out for is getting a secured business loan rather than an unsecured term loan.
A secured business loan requires you to provide the lender with some type of collateral, which serves as a second way to repay your loan in case you default on your payments.
Equipment, buildings, accounts receivable, and even inventory could be used as collateral when required.
It can be helpful in getting qualified, but it does add an extra degree of risk when taking out a term loan for your small business.
The cost largely depends on your interest rate, but is also affected by any fees charged by your lender.
Many charge an origination fee for the loan, which is deducted from your funds before they are distributed.
If you’re late making a payment, you’ll likely pay an additional fee for that as well.
Qualifying for a traditional term loan comes with a number of advantages.
Potentially Lower APR and Payments
First of all, interest rates can potentially be lower compared to those of short term business loans.
Depending on your business history and needs, you might see rates ranging between 6% and 30%.
Short term loans, on the other hand, can have APRs as high as the triple digits in some cases.
Term Loans Can Sometimes Be Larger
You might get approved for higher amounts in order to take care of larger business needs, with many lenders offering between $500,000 and $1 million.
So while short term loans are designed for smaller expenses over a short span, long term loans can allow you to put a more substantial investment into your company without worrying as much about the timeline.
Long Repayment Period
The extended repayment period that comes with business term loans could in some cases last anywhere between one and five years.
Keep in mind, that number might be even higher depending on your specific circumstances.
A longer repayment term could be extremely helpful in making payments more affordable because the expense is spread out over an extended period.
It can also give you more time to turn that new expense (or investment) into a profitable venture.
While term loans come with several perks, there are some disadvantages to be aware of as well.
Early Repayment Might Not Save You Much
One huge consideration is the cost of prepaying your loan. Business term loans sometimes amortize, meaning most of your payment goes towards interest at the beginning of the loan.
As you continue to make payments, a larger portion goes towards principal over the life of your loan.
Paying off your loan early isn’t always beneficial since most of your initial payments may go towards interest anyway.
If you’ve been making payments for a long period, you’ve probably been putting most of your money towards interest.
The amount you could save by paying off the remainder depends on your amortization schedule.
An amortization schedule is a document that outlines how much of each scheduled payment is distributed between principal interest.
Avoid only paying interest at the beginning of the loan by making extra payments.
And be sure to specifically request that the additional amount is applied to your loan principal.
Variable Interest Rates
Variable rates can also affect your repayment plan.
Depending on your loan, your interest rate, and consequently your monthly payments, could change based on how market rates perform.
This sometimes occurs on a monthly or quarterly basis.
Your lender may choose a base rate, such as the prime rate or LIBOR, then add a fixed percentage to determine your interest rate.
So if the prime rate is at 3.5% and your lenders adds 2% as your variable rate, then your interest rate for that payment would be 5.5%.
If the prime rate were to increase, your interest rate would also increase correspondingly.
Make sure you are financially prepared for such fluctuations when choosing a variable rate for your business term loan.
How To Qualify
Small business lending from banks is down 20% since the 2008 financial crisis, so it’s vital that you make your profile as strong as possible in order to qualify for funding.
Whether you’re looking for a traditional bank loan or an alternative lender, there are several steps you can take.
Each lender has different eligibility requirements, but usually they’ll have a revenue minimum along with a requisite number of years you’ve been in business.
GENIUS TIP: You don’t necessarily have to be profitable yet in order to qualify for a term loan, so don’t let this discourage you from trying.
Have Decent Credit
Lenders also look at your personal credit score in addition to your business financials, with most requiring a minimum around a 680.
That’s just below the average score in the U.S. so don’t feel too intimidated by that standard. However, it is always smart to take a look at your credit report and make sure everything is accurate and up to date.
Produce a Robust Business Plan
Develop a business plan to demonstrate how funds will be used and how you’ll be able to repay them. Provide some background on the company and your executive leadership to prove that you have the expertise to handle a growing business.
Include an Industry Analysis
Lenders want to see an industry analysis because it shows that both your own business and your general field are on a positive trajectory. Give further confidence with a robust marketing and sales strategy, as well as an operations plan. These show that you’re on top of your business everywhere it matters.
Identify Strengths, Weaknesses, Opportunities, and Threats
Finally, perform a SWOT analysis for your lender; that is, an evaluation of your strengths, weaknesses, opportunities, and threats.
A SWOT analysis will indicate to lenders that you have a realistic self-awareness of your business.
This exercise will also prepare you to meet challenges head-on, both financially and strategically.
A well-crafted business plan can add a lot of heft to your business loan application so take the time to do it right.