Term Loan, as the name suggests “a loan from a bank or financial institution for a fixed amount that is repayable in regular instalments over a fixed period of time that range between 1 to 10 years or may extend up to 30 years.” Interest rates charged on this type of loans may be fixed or floating which varies with market fluctuations. Term loan offer you option for monthly or quarterly repayment schedule with fixed maturity period.
Medium and Long Term loans are known as term loans which have maturity period of more than 1 year. Term loans are generally offered for businesses for their capital expenditure, purchase of fixed assets like land, construction of factory building, machinery, equipments etc. However, term loan can also be taken by individuals.
Term Loan Features
Purpose – Terms loans are granted for purpose of starting a new business, renovation, expansion of business, purchase of land, plant, machinery for setting up factory, construction of factory building, purchase of fixed assets etc. Terms loans are also offered for financing current asset to meet working capital requirement.
Secured Loan – Term Loans are a type of secured loans in which assets that is financed by lender act as prime security. Whereas collateral security may also be offered by borrower in addition to prime security. Security may be mortgage of land, plant and machinery, building etc.
Interest Rate – Interest rate is decided by the lender after evaluating credit risk, amount of the loan and term. Interest rates are subjected to minimum lending rate which differ from bank to bank.
Repayment – Repayment of the term loan is to be made within the fixed term in regular instalments regardless of financial health of the borrower.
Maturity Period – Term loan’s maturity period lies between 5 to 10 or 30 years however the period can be rescheduled to help the borrower in financial difficulties.
Obligation on Interest / Principal Repayment – Repayment of principal amount along with interest is definite obligation on the part of borrower regardless of the financial situation of the borrower.
Penalty – Bank or financial institution levy a penalty in case of default in repayment of principal and interest.
Commitment Fee – Commitment Fee is charged by the lender on unused credit / loan amount.
Restrictive Covenants – Beside assets security, Bank or financial institutions add a number of restrictive covenants to protect themselves. Bank ask the borrower not to raise additional finance, maintain its minimum asset base, restrain firm’s cash flow etc.
Convertibility – Term Loans can be converted into equity as per terms and conditions laid down by the lender.
Term Loan Advantages or Benefits
Term loan, one of the most common source of business financing can be availed for medium to long term. They are mainly availed for meeting working capital needs to purchase equipments and supplies for its business operations. However, Term loan have following advantages –
Easy Documentation – There is no uniform document list but term loan provides hassle free documentation and sanction process.
Cheap – Term loan is a source of low cost credit. Interest rates charged are the modest as compared to other sources of finance.
Tax Benefit – The borrower can avail tax benefit on the interest payable on term loan. However, it depends on type of term loan availed.
Flexible – There is flexibility of negotiation in terms and conditions of loan between borrower and lender.
Control – The term loan represent debt financing and interest of the equity shareholders is protected.
Security – Terms loans are secured. Bank and financial institution offer such loan against security (prime and collateral security) which eliminates the credit risk for bank or financial institution.
Income – The payment of regular instalments towards principal amount along with interest is obligatory for borrower. Thus, the lender will have a regular source of income.
Control – As Loan is convertible into equity, lender can get the right to control over affairs of the business or firm.
Before approval of the loan application, bank or financial institution check your credit history and fetch all credit records to evaluate your credit worthiness. Bank will sanction the loan only if you have good credit score or rating.