Meaning of Term Loan

Meaning of Term Loan

A term loan is a loan from financial institutions having an initial maturity of more than one year. Term loan is a contract under which a borrower agrees to make a series of interest and principal payments in an interval of specific period. Generally, term-loans have maturities of 5 to 10 years. It usually lasts between one and ten years, but may last as long as 30 years in some cases.

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. However, term loans may have maturities of 2 years or more. Funds raised from term loan is typically used to finance permanent working capital, to pay for fixed assets or to discharge other loans.

A formal term loan agreement is signed between the borrower and lender. It specifies various terms and conditions such as maturity period, payment date, interest rate, restrictive provisions, collateral etc. It is also called as a term finance which means the money raised through the term loans is generally repayable in regular payments i.e. fixed number of installments over a period of time.

Following are the features of term loans:

  • Banks or Financial institutions granting term loans are creditors and not the owners of the company. They only lend the funds to the company.
  • Return on term loans is paid in the form of interest. This interest is still paid even if there is non-availability of profits.
  • This source of raising funds is very risky from a company’s point of view.
  • They are a cheap source of funds from a company’s point of view.

Real life example; 

Let’s say Company ABC wants to borrow $2 million to build an Institution. It meets with its bank, XYZ Bank, to negotiate the loan. The company and the bank agree to a 10-year loan with quarterly payments and a 6/7/8% interest rate.

Term loans often mature within 10 years, but this is negotiable. They usually require collateral. Not all banks make term loans, and an existing relationship with a bank is usually helpful.

 

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