What is a term loan?
Understand the long and short of business financing.
When your business has an immediate one-time need for cash, or you wish to purchase an asset, you may want to consider applying for a term loan.
Broadly speaking, a term loan provides a lump sum payment of cash up front, and requires regular payments over a set time to pay back the loan plus interest to the lender. It's a common way for an established business to get access to more cash than they could save on their own, while still keeping their cash flow healthy.
Secured term loans require collateral
Other term loans are secured by collateral, such as a vehicle, equipment, or commercial real estate that is being purchased. In certain circumstances, some loans secured by real estate can be used for business purposes other than buying the property that is being offered up as collateral.
Short-, medium-, long-term loans
In the recent past, most term loans, with the exception of real estate secured loans, have tended to be for two to five years. However, there are now short-term loans for a year or less, as well as the traditional long-term loans that can go up to 25 years, such as an SBA 7(a) loan for financing commercial real estate. Ultimately, the term of the loan is matched up with the loan purpose and the collateral type.
If you have a short-term goal or need for cash which you think may provide an immediate return on investment, a bank may be able to offer a loan repaid over a short term. If you have a long-term goal instead, with an expected extended return on investment, such as purchasing a building, a bank may be able to offer a loan with a longer term so you can match repayment to the extended period.
Short-term loans can be for as little as six months1. They can be useful if you need to finance an immediate business need and may be used to help establish or re-establish business credit. Short-term loans sometimes require daily or weekly1 payments, allowing the pay down of balances quickly, which can help reduce the total cost of financing.
Medium-term loans are typically for two to five years. They can be secured by an asset you own, by what they are used to purchase, or unsecured (no collateral required). They're best for companies in "growth mode," with bright prospects, good revenue, and a pressing need to buy equipment or other tangible assets. A medium-term loan may help these business owners accelerate their plans. Instead of saving gradually for the purchase, perhaps for years, they can finance that specialized truck, X-ray machine, or restaurant equipment today. Plus, the accounting and tax benefits of ownership may help offset the interest costs. For loans that are unsecured and not tied to an asset, the approval is based only on the credit-worthiness of the business and the owners.
Long-term loans can run for 10, 15, or even 25 years. The loan amounts can range from a few thousand dollars to a few million dollars, depending on the loan program — enough for a smaller purchase, or for new locations, major expansions, or purchasing a building. In most cases these funds are tied to a particular purchase. Long-term loans can be used for many business purposes, including purchase of machinery and equipment, inventory, real estate, construction, or business expansions.
The application process
As one would expect, the bigger the loan, the more rigorous the approval process will be. In general, a bank will look at a company's financial history in detail to be sure the company's cash flow is strong enough to repay the loan. The lender might even set limits on other debt obligations to add extra assurance.
Which is right for you? The answer depends on your specific plans. Your banker is a great resource for helping you find the right option to fit your needs. Keep in mind that whichever loan you choose, you'll need to establish your financial stability. The old adage that "it takes money to make money" still holds. But if you already have some success under your belt, a term loan can help you build on your achievements, faster than you could on your own.
Visit the Wells Fargo's Business Credit Finder tool for more information.
1Wells Fargo's short-term loan is a 12-month loan with weekly payments.