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Term Loan

Definition: A loan for equipment, real estate and working capital that's paid off like a mortgage for between one year and ten years

Term loans are your basic vanilla commercial loan. They typically carry fixed interest rates, and monthly or quarterly repayment schedules and include a set maturity date. The range of funds typically available is $25,000 and greater.

Bankers tend to classify term loans into two categories:

Intermediate-term loans. Usually running less than three years, these loans are generally repaid in monthly installments (sometimes with balloon payments) from a business's cash flow. According to the American Bankers Association, repayment is often tied directly to the useful life of the asset being financed.

Long-term loans. These loans are commonly set for more than three years. Most are between three and 10 years, and some run for as long as 20 years. Long-term loans are collateralized by a business's assets and typically require quarterly or monthly payments derived from profits or cash flow. These loans usually carry wording that limits the amount of additional financial commitments the business may take on (including other debts but also dividends or principals' salaries), and they sometimes require that a certain amount of profit be set-aside to repay the loan.

Term loans are most appropriate for established small businesses that can leverage sound financial statements and substantial down payments to minimize monthly payments and total loan costs. Repayment is typically linked in some way to the item financed. Term loans require collateral and a relatively rigorous approval process but can help reduce risk by minimizing costs. Before deciding to finance equipment, borrowers should be sure they can they make full use of ownership-related benefits, such as depreciation, and should compare the cost with that leasing.

The best use of a term loan is for construction; major capital improvements; large capital investments, such as machinery; working capital; purchases of existing businesses. Fortunately, the cost of such a loan is relatively inexpensive if the borrower can pass the financial litmus tests. Rates vary, making it worthwhile to shop, but generally run around 2.5 points over prime for loans of less than seven years and 3.0 points over prime for longer loans. Fees totaling up to 1 percent are common (though this varies greatly, too), with higher fees on construction loans.

What do banks look for when making decisions about term loans? Well, the "five C's" continue to be of utmost importance.

Use the following guidelines when selecting a business bank: