Term loans come in different shapes and sizes but vary based on types of financing lenders. Banks, credit unions, online lenders, and SBA lenders provide term loan options that might fit your needs. Term loans are a versatile tool for financing large, one-time investments and working capital. Obtaining approval for this type of business loan is far from a foregone conclusion.
Certain term loans are accessible to established businesses with years of profitability. There are many variables but no right way to determine if a term loan is right for your business. You have to carefully weigh the pros and cons of a term loan and evaluate them in the context of your business goals.
The Pros and Cons of Term Loans
By reviewing the pros and cons of term loans, you can determine what most lenders that offer term loans expect and determine if this is the right funding option for you.
Pros of Term Loans
Predictable payment schedule
A term loan has a specific loan amount that needs to be paid back on a specific schedule. Therefore, unless you have a floating interest rate you know what and when your payments will be. With a floating interest rate, your business loan rate may change (either up or down) and with it, your payment.
Certain financing types, such as merchant cash advances, don’t have this type of repayment predictability. Instead, with a cash advance, you’ll receive lump sum financing that you’ll remit based on your business’s current credit card sales. As your credit card sales fluctuate, so will your remittance amount.
Potential for early loan repayment
You will need to read your loan agreement to ensure you can repay your loan early without penalty but in many cases it is possible. Repaying your loan early can reduce your interest expense and makes it easier to take on new debt. Often, business owners take out short term loans so that they can use the financing and pay off their balance quickly.
This kind of flexibility allows you to adjust your plan if circumstances change. For example, if your interest rates decrease, you can refinance your term loan and lower your monthly payment.
Low interest rates
While their rates aren’t the lowest, long-term loans tend to have lower interest rates relative to other financing options. However, while you’ll be paying more in total interest, your regular payments will be lower and their impact on cash flow will be less severe.
Cons of Term Loans
Inflexible repayment schedules
While a term loan’s repayment schedule is predictable, it is also inflexible. Especially if the loan carries a strict policy on early repayment. Unlike invoice factoring, which clears your obligation when your customer pays their balance, term loans are essentially set in stone.
Strict eligibility requirements
The borrower’s credit risk is the most important factor to consider. Plus, because term loans are typically for larger amounts, the downside is significant. To account for this risk, working capital lenders enact strict eligibility requirements.
Slow funding time
The business loan application process alone can take weeks to fully unfold on a term loan. After that, the business lender has to complete many other internal processes that can delay the funding of a term loan. In some cases, it can take a few business days, but some financing lenders have a longer qualification process.
The Bottom Line
Online lenders approve term loans more often and fund them quicker compared to banks or credit unions. Online lenders tend to change higher interest rates than banks or credit unions. At the same time, online lenders tend to charge higher interest rates than banks or credit unions.
The point here is that not all term loans are created equally. The amount, length, type of lender, and other details significantly affect a term loan’s eligibility criteria, cost, funding speed, and repayment schedule. So if you are considering a term loan, do your research on the loan and lender.