Finance is a major challenge for all business people to transform their business to next people. Availing right source of finance at right time is also a great challenge for all business people.
Term loans are the best way of choice for a business to have a large capital investment, where returns on investment, can be obtained over a longer period of time. Term loans are given on one time basis and paid in installments. Term loans can be provided under fixed and floating interest and can be paid as monthly or quarterly basis. Term loans are issued under a collateral security of residential, commercial, industrial properties or vacant land, in order to reduce the risk of payment. Term loans are paid over a period of 3 – 10 years in monthly installments. Term loans are similar to mortgage loan which requires a property against the loan amount. Generally term loans are classified under two categories namely intermediate term loans and long term loans. Intermediate term loans are matured between 3 – 5 years and mostly paid in monthly installments and long term loans are commonly set for above 5 years mostly 5 – 10 years.
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, will serve as a primary security and other assets of the company or immovable property will be taken as collateral, if need be, depending on the discretion of the bank.
- The loan has to be repaid within the fixed term
- 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 disbursal of the loan.
- The term loan’s maturity lies between 3 -10 years. The repayment of the loan is to be made in monthly instalments.
- Financial institutions impose a penalty in case of default.
- A Commitment fee is charged on the unutilized loan amount.
- Sometimes, banks allow holiday period for project term loans, depending on the viability and the feasibility of the project. In that case, the repayment will start after 6 months or 1 year as the case may be.
- As EMIs are paid, the interest will be less and the principal repayment will increase, reducing the loan amount payable.
Advantages of Term Loans
- Term loans are the best and cheap source to meet the financial requirements of the company
- Term loans are debt financing and equity is not diluted for the promoters at any point in time.
- These loans are payable over a longer period of time, hence spreading the liability over a period of time
- The lender will have a collateral security and hence the loan is not a huge risk to the financial institution
- Borrower can plan his expenses as per the term loan commitment.
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 follow the rules and norms imposed by the lenders.