For businesses, growth often requires more than just great ideas; it demands resources. Whether you’re an entrepreneur looking to expand your business, a professional wanting to upgrade equipment, or an individual with a significant personal expense, having the right financial resources can make all the difference.
A term loan can be that resource for you. It is designed to meet diverse needs of businesses and individuals from expanding a business to purchasing a home. But what is a term loan? How does it work? And why do businesses and individuals turn to it as a reliable financing option?
What is Term Loan?
A term loan is where the borrower receives a certain amount upfront and agrees to repay it over a specific time period through regular installments. These installments, commonly known as EMIs, include both the principal amount and the interest. The interest rate on a term loan can either be fixed or variable, depending on the loan agreement and market conditions.
These loans can be secured by both businesses and individuals. For individuals, these loans can help with the expenses related to education costs, home renovations, or medical bills. On the other hand, for businesses, these loans are often used to acquire assets, expand operations, or meet working capital requirements.
Moreover, the repayment tenure usually ranges from a few months to 20 years, depending on the loan’s purpose and amount.
How Does Term Loan Work?
A term loan is a type of loan where the borrower receives a one-time lump sum amount from a lender and repays it over a specified period through regular installments. These loans are widely used for personal or business needs due to their structured repayment terms and predictable costs.
Here’s a step-by-step breakdown of how it works:
1. Determining Eligibility and Loan Amount
The borrower must first meet the lender’s eligibility criteria, which is usually determined by assessment of the credit score, income, employment history, etc. Once the borrower is found to be eligible, the loan amount is decided based on their requirements, the type of term loan and their assessment.
2. Fixed Repayment Tenure
The repayment tenure is pre-decided and usually ranges between a few months to 20 years, depending on the loan type and purpose. This fixed tenure ensures that borrowers are aware of the time frame for repaying the loan in full.
3. Collateral Requirement
Term loans can be both secured or unsecured:
- Secured loans require pledging collateral, such as property or assets.
- Unsecured loans don’t need collateral but may have stricter eligibility criteria and higher interest rates.
4. Understanding Interest Rates
The interest rate on a term loan can either be fixed or floating, and this is generally determined by the lender based on market conditions and other factors. Fixed rates ensure consistent monthly payments throughout the loan tenure, while floating rates may vary, impacting the repayment amount. Borrowers are presented with the loan terms, including the applicable interest rate, as part of the offer extended by the lender.
5. Repayment Through EMIs
Repayment is structured through Equated Monthly Installments (EMIs), which consist of both the principal amount and the interest. To calculate your monthly payments, you can use online EMI calculators and plan your finances accordingly.
Types of Term Loans
Term loans are categorized based on the repayment tenure and the borrower’s needs, these include:
1. Short-Term Loans
Short-term loans are generally used for immediate financial needs and have a tenure of up to 12 to 18 months. These loans are mainly used for covering urgent expenses like working capital shortages, operational costs, or consolidating debts.
Features:
- Loan Amount: Smaller, usually suited for working capital needs or urgent business expenses.
- Interest Rates: Higher due to the shorter repayment period
- Eligibility: Businesses, particularly small businesses and startups, qualify based on their credit history and financial stability.
- These loans provide quick access to funds for immediate operational needs without long-term financial commitment.
2. Intermediate-Term Loans
Intermediate-term loans offer a repayment period ranging from 2 to 5 years. These are suitable for medium-term projects like purchasing equipment, expanding a business, or renovating facilities.
Features:
- Loan Amount: Moderate, catering to needs like asset acquisition or business expansion.
- Interest Rates: Lower than short-term loans due to a longer repayment window.
- Eligibility: Businesses, especially MSMEs, often avail these loans based on creditworthiness and turnover.
- These loans bridge the gap between short-term liquidity needs and long-term investments.
3. Long-Term Loans
Long-term loans are usually used for significant financial commitments and come with a repayment tenure exceeding 5 years, often stretching up to 25–30 years. These loans are commonly used for purchasing real estate or vehicles, funding large-scale business projects.
Features:
- Loan Amount: Larger loan amounts that can be used for substantial investments like major asset acquisition or large-scale business expansion.
- Interest Rates: Comparatively lower due to the extended repayment period.
- Eligibility: Often targeted at established businesses, particularly MSMEs, with eligibility based on creditworthiness, financial stability, and turnover.
- These loans provide the necessary capital for significant growth and long-term investments, offering flexibility while balancing financial stability.
Benefits of Term Loan
The benefits of term loan include:
1. Flexible Repayment Options
With structured repayment schedules, term loans allow borrowers to repay in manageable installments over a previously agreed-upon tenure. This flexibility helps maintain cash flow and avoid financial strain.
2. Customized Solutions
Loans are personalized based on the borrower’s profile and specific needs. Lenders customize the loan amount, tenure, and interest rate according to factors such as credit scores and financial goals, ensuring that the loan suits the borrower’s requirements.
3. Tax Benefits
The interest paid on term loans is in some cases eligible for tax deductions, reducing the overall cost of borrowing. This is especially beneficial for businesses looking to optimize expenses.
4. Multiple Usage Options
Term loans can be utilized for diverse purposes, including expanding businesses, purchasing equipment, consolidating debt, or funding personal goals like higher education or a home purchase.
5. Quick Approval and Disbursal
With easy application procedures, term loans often have fast approval processes. Many lenders also offer online services, reducing paperwork and speeding up disbursement.
6. Boosts Business Cash Flow
For businesses, term loans provide the capital needed to improve cash flow, invest in growth, and reduce dependency on working capital.
Factors Affecting the Eligibility for Term Loans
There are some factors that lenders consider to assess the borrower’s ability to repay and the associated risks. Here are some of the major factors that determine a person’s or business’ eligibility for a term loan.
1. Credit Score
A credit score determines how financially responsible a borrower is. Making timely repayments and efficiently managing debt can improve one’s credit score, enhancing the chances of approval.
2. Financial Stability and Statements
Lenders check your financial records, including revenue, profit margins, for businesses and income proof for individuals. A steady income, profitability, and sound financial management are essential to demonstrate that you can meet the repayment obligations.
3. Business Plan
For business loans, a well-prepared and realistic business plan is essential. It should detail how the loan will be used, the projected impact on business growth, and how the borrower plans to generate enough revenue to repay the loan.
4. Debt-to-Income Ratio
A balanced debt-to-income ratio signals financial prudence. Lenders prefer borrowers who maintain a healthy balance between borrowed funds and their own income, ensuring that they are not overly reliant on debt.
5. Repayment Capacity
Lenders assess your ability to repay based on cash flow and future income projections. A stable income stream or positive cash flow significantly strengthens the loan application.
6. Industry Risk
The industry a business is in and the risks associated with it also influence eligibility. Lenders may be cautious if you work in a high-risk industry that faces economic volatility or regulatory challenges.
7. Borrower’s Credibility
A borrower’s track record of timely debt repayment and their overall reputation also affect approval. Individuals or businesses with a proven history of clearing debts on time are viewed more favorably, often qualifying for lower interest rates.
Conclusion
A term loan is a practical financing solution for individuals and businesses looking for long-term stability and growth. With its clear structure, flexible options, and numerous benefits, it is an ideal choice for managing significant expenses, making large purchases, or achieving personal or professional goals.
Whether you’re looking to fund a business expansion, pay for medical expenses, or consolidate debt, LoanTap offers customized solutions through both business loan and personal loan. With quick approvals, flexible repayment terms, and competitive rates, LoanTap offers customized solutions to meet your unique needs.
Frequently Asked Questions
How is a term loan different from a credit line?
A term loan provides a lump sum amount to be repaid in installments, while a credit line offers revolving funds that can be borrowed as needed up to a limit.
Can I prepay my term loan?
Yes, most lenders allow prepayment of term loans, though some may charge a prepayment penalty.
How does the loan amount for a term loan get decided?
The loan amount depends on the borrower’s financial profile, repayment capacity, the type of loan and its purpose.
What is the difference between fixed and floating interest rates for term loans?
A fixed interest rate remains constant throughout the loan tenure, while a floating rate fluctuates based on market conditions.
How can I apply for a term loan with LoanTap?
To apply for a term loan from LoanTap, visit the official website or app, fill in your details, upload the necessary documents, e-sign the agreement and submit the application. Once your application is verified and approved, the loan amount will be disbursed into your bank account within 24 hours.
