A term loan is a simply a loan that is given for a fixed duration of time and must be repaid in regular instalments. These loans usually extended for a longer duration of time which may range from 1 year to 10 or 30 years. Rate of interest charged under these loans may be on a fixed or floating basis, which will vary with market fluctuations. Term loans are mostly used as small business loans but can also be taken on an individual basis as well.
Features of Term Loan
The features of term loans are as follows:
- Term loans are Secured Loans. The asset that is purchased using the term loan amount, will serve as a primary security and other assets of the company will be serving as collateral security.
- The loan has to be repaid within the fixed term regardless of the firm’s financial situation.
- The interest rate on the loan is charged after evaluating the credit risk of the proposal, the loan amount and tenure for which the loan is taken. The interest rate will be subject to a minimum lending rate.
- The rate is negotiated between borrowers and lenders at the time of distributing the loan.
- The term loan’s maturity lies between 5 -10 years. The repayment of the loan is made in instalments. The tenure can be rescheduled to help borrowers deal with the financial emergencies.
- The lender will ask the borrower not to raise additional loans and to repay the existing loans and maintain a minimum asset base.
- Term loans can be converted into equity according to the terms and conditions that have been laid out by the lender.
- Financial institutions impose a penalty on the defaults.
- Commitment fee is charged on the unutilized loan amount.
- The principal loan amount is to be repaid after the initial grace period of 1 – 2 years.
- Commercial banks’ term loan are repayable in equal quarterly instalments whereas financial institutions’ term loan are repayable in equal semi-annual instalments.
- Servicing burden of the loan declines over time. The interest will be less and the principal repayment will remain constant.
- Advantages of Term Loans
- The loan is cheap for the borrower.
- The interest that the borrower pays on the term loan is tax deductible and hence can avail tax benefit on the interest paid.
- The term loans are negotiable and hence the terms and conditions of the loan are not rigid.
- The term loans represent debt financing and the interest of the equity shareholder is not weakened.
- The lender will have a collateral security and hence the loan is not a huge risk to the financial institution.
- Since the borrower will be making regular payments towards the principal loan amount and interest, the lender will have a regular and steady income.
- Since the loan can be converted to equity, the lender can get the right to control the affairs of the business or firm.
- Disadvantages of Term Loans
- If the borrower fails to make the repayments, the lender will question the borrower’s liquidity position and the company’s existence will be at stake.
- Debt financing increases the financial risk of the company. It adversely affects the benefits of the shareholders.
- In addition to the collateral security, the borrower will have to tend to the restrictive covenants imposed by the lenders. The borrower will have to close the existing loans and must maintain the asset base and not take another loans. This causes unnecessary interference in the firm’s functioning.
- Since the terms and conditions are negotiable, there is chance that it might affect the interest of the lender.
- The lender of term loan will have no control over the company’s affairs and it leads to the lender asking the borrower to convert the loan to equity.
