What Is A Term Loan?
A term loan is a short term or long term loan that is given for a stipulated period. Financial institutions provide these loans on a condition of repayment in fixed instalments (EMI) along with interest. They are offered at both floating and fixed rates of interest. The repayment tenure of term loans ranges between 12 months to 60 months. Personal loans, business loans, auto loans, education loans, gold loans, and home loans are some examples of term loans.
| Objective | Ideal for any asset purchase or business expansion |
| Loan Type | Collateral Free / Unsecured |
| Maximum Amount | Up to 50 Lacs |
| Who can avail | Manufacturer, Traders, Service providers, Retailers, E-commerce, Food, Hotels & Travel. |
| Interest Rate | Starting at 1.5% PM |
| Repayment Tenure | Upto 36 Months |
| Business Vintage | Minimum 1 year |
| Disbursal Time | Get disbured your loan amount in 3 days* |
| Processing Fee | ~ 4% |
| Term Loan Examples | Business loans, MSME loans, Line of Credit loans, Overdraft loans etc |
Term Loan Meaning
Term loans are the amount that are commonly granted to the small businesses. Along with the amount, the repayment schedule of the term loan is also pre-determined. However, these loan interest rate might be fixed or floating. Generally, the tenure of these loans goes up to 5 years, but occasionally, the mandate for these loans can extend up to 10 years.
These loans are not for personal use and hence, are offered only to businesses for capital expenditure and business expansion amongst others. They are often tailor-made to suit the financial needs of MSME businesses. There are also various benefits of using this loan to raise capital. The benefits include a requirement of minimal documentation, quick and easy disbursal of the required funds, as well as flexibility in repayment of the loan.
Types of Term Loan:
There are various types of term loan that businesses can choose from. They are often suited to the requirements of borrowers based on factors like- the amount of funding required by the business, the repayment capacity of the borrower and the financial health of the company in terms of cash flow and in-hand availability of cash. Most terms of the loan, including the rate of interest to be charged on the loan depends on factors like these. The most common classification of term loan is done in terms of the loan tenure. Hence, the types of term loan are as follows:
These are term loan which have a maximum tenure of 2 years. Mostly, these loans have tenures of 1 to 2 years. These kinds of loan are primarily used for the day-to-day requirements of the business or for the fulfilment of the working capital needs of the business. There are various sources from which a business can get a short term loan. They are- commercial banks, trade credit, discounting bills of exchange etc.
Usually, short term business loans have a rate of interest which is higher than the other type of term loan, principally due to the shorter time frame. These loans may even involve weekly repayment schedules if the loan tenure is very short. Any business willing to procure such a loan should be mindful of the fact that not only these loans have rates of interest, but the charges are also higher, in case the business defaults on any instalment.
These are loan which have a tenure of 2 to 5 years. These types of loans could be said to be a hybrid of the short termand long term loans. In most cases, these types of loans are procured by businesses to carry out renovation or repairing of a fixed asset. An example could be the renovation of a showroom. The characteristics of these loans are somewhat a mixture of short and long term loans. The rates of interest charged are higher than the long-term loans; however, the documentation during the loan application process is relatively more comfortable when compared to longer-term loans.
They are term loan which, in a majority of the cases, have a tenure of over five years. The tenures can even extend up to 25 or 30 years depending on the nature of requirement. Due to the higher ticket size of loans and higher associated risks, most of the long term loans are secured, i.e. they require collateral. Examples for these kinds of loans are home loan, car loan or loan against property etc. In the case where the loans are secured, the rates charged are also lower. However, there are cases where even long term loans are unsecured. In such cases, the interest rates charged are higher due to the higher risk involved.
Advantages of Term Loan
Acquiring working capital to buy any equipment and supplies for essential business activities is the main motive of a these loan. The bank's money guarantees you have the funds to purchase things for the organization as needed, which offers you a feeling of serenity.
| Cheap | Term credits are the least expensive source of short term finance. They are also considered for medium term finance. |
| Tax reduction | The amount of interest of these loans falls under tax-deductible expenditure. Therefore, the tax advantage is accessible to such interest. |
| Flexibility | These loans are negotiable. Therefore, they can be easily negotiated between the borrower and the bank. Even the T&C (terms and conditions) of these loans are flexible and not rigid. |
Control | The term loan represents debt financing. So the equity shareholders do not lose their interest, and it isn't weakened. | Least eligibility requirements | You can easily avail of these loans. The least eligibility criteria include the submissions of a few essential documents, making the whole process of loan hassle-free. |
Disadvantages of Term Loans
Though these loans are considered one of the best sources for outside credit; still, one should be cautious enough not to land in detrimental financial circumstances. A few disadvantages of these loans are:
| Commitment | Yearly interest installments, and reimbursement of the principal amount is mandatory for the borrower. The inability of not meeting these installments brings up an issue on the borrower's liquidity position, and its reality will be in question. |
| Risk | Term credits, like any other kind of debt financing, also increase the company's financial risk. Debt financing benefits only if the concerned inward return rate is more noteworthy than its capital cost; else, it unfavorably affects shareholders' advantage. |
How does a Term Loan Work?
Due to various reasons like pre-determined loan value and repayment schedule, interest rates etc., these loan are one of the most convenient loans for businesses to avail. There are various aspects which are required to be understood for the business to comprehend how a term loan works. There are five aspects of a term loan: the loan value, interest rate, loan tenure, the repayment schedule, and whether the loan is secured or unsecured.
The loan value of a this loan is fixed. This amount depends on the type of loan chosen as well as the eligibility of the borrower. The business loan interest rate charged on this loan can be fixed or floating. It depends on the borrower what kind of rate it opts for. The loan tenure is also pre-determined. The business must pay the amount availed in EMIs according to the predetermined repayment schedule throughout the loan tenure. Finally, the loans availed can be secured or unsecured. However, unsecured loan would have a higher rate of interest when compared to secured loans.
Key Facts About Term Loan
Terms loans are of three types - long term, short term, and medium term loans.
Small and medium businesses go for term loans to cater to their working capital and expansion needs.
Timely payments can improve the creditworthiness and credit score of the applicant.
Term loans are ideal for obtaining immediate funds for beginning new projects or meeting immediate goals.
Terms loans can be both secured and unsecured. However, it will depend upon the borrower’s eligibility and loan amount.
Borrowers can pay off their term loans before schedule, and no penalty will be imposed for this.
Term Loan EMI Calculator
Refer to the below example to understand the easy working of this loan
A businessman wants an amount of Rs.30 lakh to buy machinery to expand his business activities. So he applied for the loan, along with the necessary documents. However, after assessment, the bank stated that his eligibility for a loan is up to Rs.20 lakhs only.
The institution accordingly offers him the terms and conditions of the loan, alongside the interest rate applicable. The tenor is chosen for 6 years. The reimbursement timetable would subsequently be –
Number of EMIs = 6x12 months = 72.
The borrower should reimburse the full loan amount with the last settlement in 72 EMIs. The EMI amount relies upon the term loan interest rate, along with the amortization plan of the bank. On the off chance that money is accessible in some lump sum amount, the borrower may likewise settle on the loan amount's dispossession or part-prepayment any time before ending the loan's tenor. The borrower can calculate the EMI using term loan emi calculator.
Term Loan Eligibility & Documents Required
| Eligibility | Documents Required |
| Minimum operational history of 1 years | Business Registration Proof |
| ITR required for annual turnover > Rs.5 Crores | KYC documents of the applicant and the organisation |
| Bank statement for the last 6 months |
| Pan Card of the promoter |
| Aadhaar Card of the promoter |
FAQ Related to Term Loan
Here are some Frequently Asked Questions (FAQs) related to these loans, or term financing, offered to businesses:
- Why is a term loan?
A term loan is a loan, usually from a bank, taken by a business wherein the amount to be borrowed is specified.
- Why is a term loan given to businesses?
Businesses often face the need for cash for many purposes, and the these loans are given to corporates for this purpose of meeting their cash requirements. These requirements could be to meet their working capital requirements, or to finance a new project. It could also be to buy new machinery, or to build a new manufacturing unit.
- What are the different types of term loans?
These loans differ based on their tenure, which varies from one business to another. These could either be short term loans ranging from a few days to a year, or they could be medium term in nature. These medium term loans are somewhere between a year to 18 months, to even 84 months.
The repayment is done in the form of monthly instalments from the cash flows of the borrowing company. A long term loan is usually beyond 84 months to even 25 years, and companies have to pledge their assets as collateral to get these long term loans.
- What are some of the common characteristics of a term loan?
Based on the interest rate assigned to these loans, they are classified as either fixed interest rate loans, or variable interest loans. These interest rates could have been linked to LIBOR (London Inter-Bank Offered Rate), or Prime Lending Rate (PLR), or Repo Rate linked, or MCLR (Marginal Cost of Funds based Lending Rate) based, etc. When it comes to repayment or amortisation schedule, it can be weekly, monthly, quarterly, bi-annually, or annually.
From the perspective of collateral requirement, these loans can be either secured loans or unsecured loans. The former involves the lender taking collateral, and the latter is a collateral-free loan. The lender stores this collateral to hedge the credit risk involved in a loan. There are some fees as well in the likes of prepayment fees, late payment penalty or foreclosure charges that are levied on early closure of loan or late payment of EMI.
- Can a business get tax exemptions for money paid towards loan repayment?
Yes, for a business that has taken a term loan, the interest component on the EMI (equated monthly instalment) is tax-deductible. The interest component on your loan repayment is something you can show as a business expense. Thus, it helps in getting tax exemptions for the business as it is subtracted from a business’s gross income, thereby reducing taxable income. However, the principal part of the loan is not subject to any tax rebate, only the interest part is.
Conclusion
Due to the various advantages provided by these loans like the flexibility of loan tenure, ease of repayment via affordable EMIs, easy application and documentation process, and limited cost of borrowings, they are one of the most preferred instruments of lending and borrowing. Indifi is a company that leverages technology to provide the borrower with the required funds at the best rate possible without the need for any collateral. Indifi is a market leader in this domain. Hence, if a business is looking to take up a business loan at the cheapest rate, it should consider Indifi as an option.
