A term loan is a loan from a bank for a specific amount that has a specified repayment schedule and a fixed or floating interest rate. It is a deal between a borrower and a lender where the lender provides cash upfront and receives that money back through a series of smaller payments over a certain amount of time (repayment terms). As an incentive for the lender, the borrower pays a percentage of interest.

A business term loan helps business owners with large purchases thanks to the way installment loans work—it spreads the impact of one large cost over many smaller fixed payments (installments) to the lender. Similar to how a student loan helps students invest in their futures, this financial aid can help a small business purchase a new location, vehicle, or piece of equipment that will improve future profits.

While useful and often necessary for business growth, term loans, of course, come with a cost to the borrower. Beyond the monthly payments, these costs might include the following:2

• Interest
• A down payment (if buying real estate or another business)
• An origination fee for starting the loan
• Underwriting fees or closing costs

Whether you’re seeking business loans or your own long-term personal loan, don’t forget to include these additional costs in your planning.

In another example, let’s say a small clothing vendor has seen plenty of financial success and wants to expand to a new location in a nearby town. While they have plenty of cash flow, it would still take a long time to save enough money to open a new store. So a term loan lets the clothing company open that store right away—that way they don’t miss out on that extra income.

In some ways, a business loan works similarly to a short-term personal loan, like one used to buy a car. For example, a moving company with good credit could use the up-front cash from a loan to satisfy increasing demands with additional trucks. Other types of machinery required to run a business could also be purchased with a short-term loan.

However, business loans aren’t only for large single-item purchases. For example, if a sports equipment store needs to expand its inventory for a new season quickly, a small loan with a short term can help stock the shelves just in time for the ski or snorkel rush.

The Pros and Cons of Term Loans

Term loans are a common financing vehicle for businesses. If you need money to finance your business, a term loan might offer a solution. All term loans are characterized by a fixed repayment period. When you acquire a term loan, you’ll have to repay it within a specific amount of time. This length of time is referred to as the term. Like all loans, though, term loans offer both advantages and disadvantages as a financing vehicle.

Pro: Retain Ownership

You’ll retain ownership of your business when using a term loan. All term loans are a form of debt financing. With debt financing, you’ll incur debt without forfeiting equity stake in your business. Rather, you’ll retain complete ownership of your business.

Pro: Different Lengths

Term loans are available in different lengths. There are short-term loans, and there are long-term loans. Short-term loans include those with a repayment period of less than one year. In comparison, long-term loans include those with a repayment period of more than one year. Most lenders offer both types of term loans. As a result, you can find a term loan to meet the needs of your business.

Pro: Fast

The approval time for term loans is typically faster than that of other financing methods. You probably won’t get approved for a term loan immediately. Most lenders have an approval process that can take anywhere from a few weeks to a few months. Nonetheless, term loans have a faster approval process than many other financing methods, which is one of the reasons why so many businesses use them.

Con: Interest Fees

Term loans come with interest fees. After all, interest is essentially how lenders make money from the term loans that they offer. You’ll have to repay the principal of the term loan while simultaneously paying interest fees.

With that said, short-term loans typically have lower interest fees than their long-term counterparts. If you’re worried about interest fees clogging up your business’s cash flow, you may want to choose a short-term loan.

Con: Regular Payments

You’ll have to make regular payments to the lender from which you acquire a term loan. Some lenders require monthly payments, whereas others require bi-weekly payments. Regardless, you’ll need to remember to make these payments. Failure to make timely payments could result in either your credit score or your business’s credit score taking a hit. And if you used collateral to secure the term loan, the lender may claim ownership of it.