What are term loans?

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Term loans are a type of financing programs with a specific, pre-determined maturity date and are usually paid back through monthly or quarterly installments. At its maturity date, the term loan’s original principal balance and all interest accrued will have been paid off.

There are many variations of the term loan. The key element of the term loan, however, is the maturity date, which determines its loan term (or repayment period).

In contrast, many revolving loan accounts are more open-ended, with no maturity date. Revolving accounts typically give the borrower a line of credit, against which the borrower can draw funds. The borrower will then pay back all or a portion of the credit line used, according to the agreed-upon loan terms.

Strictly speaking, almost all types of home mortgages, automobile financing and various types of personal loans can be classified as term loans. However, the label “term loan” is used primarily in the business and commercial loan market.

Term loan features and factors

As noted above, term loans typically have most, if not all, of the features found in a traditional loan:

  • Loan principal. The borrower normally receives a lump sum amount when the loan is executed. In some cases, the loan funds may be sent directly to a vendor, contractor or seller.
  • Interest rate. Depending on the lender and loan guidelines, the interest rate for the loan may be fixed or variable. Variable or adjustable rate loans will allow the lender to change the interest rate for the loan, within pre-established parameters and at specified intervals. Some variable loans are interest-only, which means that the required installment payment will only cover the interest charges due on the loan for that period.
  • Loan repayment. The loan agreement will outline the borrower’s repayment obligation. Depending on the loan, the borrower may have to make monthly, quarterly or annual payments. The payments may be amortized (paying the interest due as well as a portion of the principal) or interest only.
  • Maturity date. The term or life of the loan will vary and may sometimes be negotiable. Many banks consider term loans with a life of more than three years to be long-term loans. As such, term loans usually have maturity dates of less than ten years.

Commercial banks typically have set guidelines for their term loan programs, with interest rates established by public indexes. However, some businesses may be able to negotiate on the loan features.

Finding and using term loans

Most commercial banks, especially those serving local businesses, offer term loan programs. Businesses that qualify for and receive term loans typically use these funds to preserve their operating capital, while pursuing expansion, acquisitions or other investments.

Term loans are often used to finance the purchase of new equipment, facilitate a transfer of ownership or allow the borrowing company to acquire other businesses. Applications for commercial term loans are usually reviewed, underwritten and approved based on the qualifications of the borrowing company, including the borrower’s revenues and available assets.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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