# Understanding Term Loans: Definition, Types, and Key Attributes

![Term Loan: Borrowing a lump sum with an agreed schedule for repayment.](https://www.investopedia.com/thmb/7L-jWFWTR29EizvYsuFVaQo7138=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/terms_t_termloan_FINAL-c1e9e252157e408c8f0f549338f2411b.jpg)

*— Investopedia / Daniel Fishel*

> **Definition**
>
> A term loan is financing with fixed or variable interest rates that provides borrowers with a lump sum of cash upfront, which they repay over a specified period.

## What Is a Term Loan?

A term loan provides borrowers with a lump sum of cash upfront in exchange for specific borrowing terms. Term loans are normally meant for established small businesses with sound [financial statements](https://www.investopedia.com/terms/f/financial-statements.asp). In exchange for a specified amount of cash, the borrower agrees to a certain repayment schedule with a fixed or [floating interest rate](https://www.investopedia.com/terms/f/floatinginterestrate.asp). Term loans may require substantial [down payments](https://www.investopedia.com/terms/d/down_payment.asp) to reduce the payment amounts and the total cost of the loan.

### Key Takeaways

*   Term loans are typically used by small businesses to purchase fixed assets like equipment or real estate, which are vital for operational growth and stability.  
    
*   These loans provide a lump sum up front and require monthly or quarterly payments, offering either fixed or variable interest rate options, which adds flexibility in financial planning.  
    
*   Short-term loans often run less than a year and might include balloon payments, while long-term loans can extend up to 25 years, using company assets as collateral.  
    
*   The application for term loans involves demonstrating creditworthiness, which includes providing detailed financial statements to lenders.  
    
*   Borrowers benefit from term loans through a relatively simple application process, downstream cost savings from lower interest rates, and the freeing up of cash flow for other business activities.  
    

## In-Depth Look at Term Loans

Term loans are often given to small businesses needing cash for equipment, a new building, or other [fixed assets](https://www.investopedia.com/terms/f/fixedasset.asp). Some businesses borrow the cash they need to operate on a month-to-month basis. Many banks have established term loan programs specifically to help companies in this way.

Business owners apply for term loans similarly to other credit options by approaching their lender. They must present statements and financial evidence to show their creditworthiness. Approved borrowers receive a [lump sum](https://www.investopedia.com/terms/l/lump-sum-payment.asp) and must make regular monthly or quarterly payments.

Business owners apply for term loans similarly to other credit options by approaching their lender. Approved borrowers receive a [lump sum](https://www.investopedia.com/terms/l/lump-sum-payment.asp) and must make regular monthly or quarterly payments.

Term loans carry a fixed or [variable interest rate](https://www.investopedia.com/terms/v/variableinterestrate.asp) and a set maturity date. If the proceeds are used to finance the purchase of an asset, the [useful life](https://www.investopedia.com/terms/u/usefullife.asp) of that asset can impact the repayment schedule. The loan needs collateral and a strict approval process to lower the risk of [default](https://www.investopedia.com/terms/d/default2.asp). As noted above, some lenders may require down payments before they advance the loan.

Borrowers often choose term loans for several reasons, including:

*   Simple application process
*   Receiving an upfront lump sum of cash
*   Specified payments
*   Lower interest rates

A term loan also frees up company cash flow for other uses.

> **Fast Fact**
>
> Variable-rate term loans are based on a benchmark rate like the U.S. prime rate or the London InterBank Offered Rate (LIBOR).

## Different Varieties of Term Loans Explained

Term loans come in several varieties, usually reflecting the lifespan of the loan. These include:

*   **Short-term loans:** These types of term loans are usually offered to firms that don't qualify for a line of credit. They generally run less than a year, though they can also refer to a loan of up to 18 months.
*   **Intermediate-term loans:** These loans generally run between one to three years and are paid in monthly installments from a company’s [cash flow](https://www.investopedia.com/terms/c/cashflow.asp).
*   **Long-term loans:** These loans last anywhere between three to 25 years. They use company assets as [collateral](https://www.investopedia.com/terms/c/collateral.asp) and require monthly or quarterly payments from profits or cash flow. They limit other financial commitments the company may take on, including other debts, [dividends](https://www.investopedia.com/terms/d/dividend.asp), or principals' salaries, and can require an amount of profit set aside specifically for loan repayment.

Both short- and intermediate-term loans may also be balloon loans and come with [balloon payments](https://www.investopedia.com/terms/b/balloon-payment.asp). This means the final installment swells or balloons into a much larger amount than any of the previous ones.

> **Important**
>
> While the principal of a term loan is not technically due until maturity, most term loans operate on a specified schedule requiring a specific payment size at certain intervals.

## Real-World Example: Understanding Term Loans in Practice

A [Small Business Administration](https://www.investopedia.com/terms/s/small-business-administration.asp) (SBA) loan, officially known as a 7(a) guaranteed loan, encourages long-term financing. Short-term loans and revolving credit lines are also available to help with a company’s immediate and cyclical working capital needs.

Maturities for long-term loans vary according to [the ability to repay](https://www.investopedia.com/terms/a/ability-to-repay.asp), the purpose of the loan, and the useful life of the financed asset. Maximum [maturity dates](https://www.investopedia.com/terms/m/maturitydate.asp) are generally 25 years for real estate, up to 10 years for working capital, and 10 years for most other loans. The borrower repays the loan with monthly principal and interest payments.

As with any loan, an SBA fixed-rate loan payment remains the same because the interest rate is constant. Conversely, a variable-rate loan's payment amount can vary since the interest rate fluctuates. A lender may establish an SBA loan with interest-only payments during a company's startup or [expansion](https://www.investopedia.com/terms/e/expansion.asp) phase. As a result, the business has time to generate income before making full loan payments. Most SBA loans do not allow balloon payments.

The SBA charges the borrower a [prepayment](https://www.investopedia.com/terms/p/prepayment.asp) fee only if the loan has a maturity of 15 years or longer. Business and personal assets secure every loan until the recovery value equals the loan amount or until the borrower has pledged all assets as reasonably available.

## Why Do Businesses Get Term Loans?

A term loan is usually meant for equipment, real estate, or working capital paid off between one and 25 years. A small business often uses the cash from a term loan to purchase fixed assets, such as equipment or a new building for its production process. Some businesses borrow the cash they need to operate from month to month. Many banks have established term loan programs specifically to help companies in this way.

## What Are the Types of Term Loans?

Term loans come in several varieties, usually reflecting the lifespan of the loan. A short-term loan, usually offered to firms that don't qualify for a line of credit, generally runs less than a year, though it can also refer to a loan of up to 18 months or so. An intermediate-term loan generally runs more than one to three years and is paid in monthly installments from a company’s cash flow. A long-term loan runs for three to 25 years, uses company assets as collateral and requires monthly or quarterly payments from profits or cash flow.

## What Are the Common Attributes of Term Loans?

Term loans carry a fixed or variable interest rate, a monthly or quarterly repayment schedule, and a set maturity date. If the loan is used to finance an asset purchase, the useful life of that asset can impact the repayment schedule. The loan requires collateral and a rigorous approval process to reduce the risk of default or failure to make payments. However, term loans generally carry no penalties if they are paid off ahead of schedule.

> **Article Sources**
>
> 1.  U.S. Small Business Administration. "[7(a) Loans](https://www.sba.gov/funding-programs/loans/7a-loans)."
>     
> 2.  Corporate Finance Institute. "[Short Term Loan](https://corporatefinanceinstitute.com/resources/knowledge/finance/short-term-loan/)."
>     
> 3.  Sofi. "[What Are Common Small Business Term Loans](https://www.sofi.com/learn/content/business-loan-terms/)?"
>     
> 4.  U.S. Small Business Administration. "[Terms, Conditions, and Eligibility](https://www.sba.gov/partners/lenders/7a-loan-program/terms-conditions-eligibility)."