Key Takeaway Table
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Definition
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A traditional term loan involves getting a lump sum from a lender and repaying the amount over a set period in regular instalments plus interest. Business owners can obtain term loans from both bank and non-bank lenders, but the specific terms and conditions may vary widely.
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Uses for Business Term Loans
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Term loans can be used for any business purpose. These can include working capital, equipment finance, investments in significant assets, commercial property, research and development, inventory, and marketing. Term loans can also be used for tax debt consolidation, business expansion or the purchase of another business.
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Unsecured vs. Secured Term Loans
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Term loans can be secured or unsecured. Secured term loans require borrowers to mortgage properties or assets to the lender as a way to secure the loan. This way, the lender is protected in the case of default. Unsecured loans may not require property, but they may come with higher rates and shorter loan terms as a way for lenders to mitigate risk.
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Fixed vs. Variable Interest Rates
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Business loan terms can either have fixed or variable interest rates. Fixed-rate loans lock in the interest rate for a period whereas, a variable-rate loan changes interest rates at any time depending on market rates and other factors.
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Basic Requirements
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The basic requirements depend on the type of loan and lender you’re applying to. Banks will typically require full financials, whereas unsecured and private lenders will require little or no documentation.
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As a business owner, one of the most common financing options you have is the traditional term loan. A term loan can get you the funding you need for various business purposes. Let’s take a look at its key features, requirements, and what you can use them for:
What’s a Business Term Loan?
Key Features
- Loan Amount: This is the total amount borrowed. It can range from a few thousand to millions of dollars, depending on the business's needs and the lender's terms.
- Interest Rate: The interest rate is the cost of borrowing money, usually expressed as a percentage of the total amount. The interest rate can be fixed or variable.
- Term Length: The repayment period can vary from short-term (usually 12 months or less), to medium-term (1 to 5 years), and to long-term (more than 5 years) loans.
- Repayment Schedule: Payments are typically made monthly, quarterly, or annually, covering both principal and interest.
- Other Fees: Lenders may charge other fees on top of the interest rate.
- Security: Some term loans are secured, meaning they require property security or other real property assets that guarantee the loan.
Uses for Business Term Loans
Business term loans can be used for any business purpose – here are some common uses for term loans:
- Significant Investments: Investing in long-term assets such as property, plant, and equipment to expand operational capacity or efficiency.
- Debt Refinancing: Paying off existing debt to secure a lower interest rate or more favourable terms.
- Business Expansion: Funding new initiatives, entering new markets, expanding business offerings, and purchasing additional locations or larger facilities.
- Inventory Purchase: Purchasing bulk inventory to start a business, prepare for seasonal demand spikes, take advantage of bulk discounts, or launch new products.
- Research and Development (R&D): Investing in innovation to develop new products or services, improve existing offerings, or enhance competitive advantage.
- Marketing and Advertising: Funding campaigns to promote the business, attract new customers, enter new markets, or launch new products or services.
- Business Acquisitions: Financing the purchase of another business or its assets to expand market reach, customer base, or product offerings.
Unsecured vs. Secured Business Term Loans
When applying for term loans, business owners can choose between secured and unsecured loans. The choice between the two depends on the borrower’s needs, financial condition, and risk tolerance.
Businesses and directors with significant assets that can be offered as security might prefer secured loans, while those without substantial assets might opt for an unsecured loan. The primary difference between unsecured and secured term loans lies in the requirement of security:
Secured Term Loans
Secured loans are backed by security, which means the borrower must offer an asset as security for the loan. This security could be real estate, equipment or other assets owned by the business.
Because the lender has the security to fall back on in case of default, secured loans typically come with lower interest rates and better overall terms compared to unsecured loans. If the borrower fails to repay the loan, the lender has the legal right to seize the security to recover the outstanding debt.
Unsecured Term Loans
Unsecured loans do not usually require any property or asset security. Instead, the lender evaluates the loan application based on the borrower’s creditworthiness, including credit history, income, and the overall financial health of the business. Although security is not needed, lenders typically require a personal guarantee from directors, meaning they can be personally liable for repaying the loan if the business fails to do so.
The absence of security means the lender takes on more risk, which is typically reflected in higher interest rates and shorter loan terms. However, approvals can be received in a day. Thus, if funds are needed in a hurry, unsecured term loans can be beneficial.
Fixed-rate vs. Variable Rate Term Loans
The difference between fixed rate and variable rate business term loans lies in how the interest rate is applied and how it affects the repayment amount over the life of the loan. Each type has its advantages and disadvantages, depending on the economic environment, loan duration, and borrower’s preference.
Fixed Rate Business Term Loans
A fixed-rate term loan has an interest rate that remains constant throughout a set period. This means the regular repayments do not change within the fixed period, providing predictability in budgeting and financial planning.
While the interest rate is locked, it will be unaffected by any economic or market changes, which can make it easier for businesses to manage their cash flow effectively.
Variable Rate Business Term Loans
The interest rate on a variable-rate term loan can change over time based on several factors, primarily the cash rate set by the Reserve Bank of Australia. As the benchmark rate fluctuates, so does the loan’s interest rate and consequently the repayment amount. When the market rates decrease, the loan’s interest rates and repayments also decrease. However, when rates increase, a borrower can expect their repayments will normally rise.
Basic Requirements
When applying for a business term loan, borrowers will need to reach certain criteria and demonstrate their capacity to pay the loan. However, it’s important to note that requirements differ from lender to lender. Lenders like banks may have more detailed requirements, while non-bank lenders often have less. It’s important to compare lenders before making a decision. Here are some of the basic requirements for business term loans:
Credit Score
The director’s credit score and the business's credit history may be scrutinised by lenders. A higher credit score can improve the chances of loan approval and secure more favourable loan terms. Directors with lower credit scores may still get loans from non-bank lenders, but they may be restricted when it comes to choosing loan types and amounts. They will also be charged higher interest rates.
Financial Statements
Some lenders require financials for the approval of term loans, along with cash flow statements and tax portal documentation. Lenders use these documents to assess the financial health of the business, its profitability, and its ability to generate cash flow to repay the loan.
Time in Business
Although some lenders offer loans to startups, some still have a minimum requirement for how long a business has been operating. These lenders often prefer businesses that have been in operation for at least two years.
