Term loan: Overview, definition, and example
What is a term loan?
A term loan is a type of financing in which a borrower receives a lump sum of money from a lender and agrees to repay it over a set period with regular payments, often including both principal and interest. Term loans typically have fixed or variable interest rates and can be secured by collateral or unsecured. They are commonly used by businesses for capital investments, equipment purchases, or expansion projects.
For example, a small business might take out a term loan to buy new machinery and repay it over five years with monthly payments.
Why is a term loan important?
A term loan is important because it provides businesses with a predictable way to finance significant expenses or investments. The fixed repayment schedule allows for better financial planning, while the lump sum provides immediate access to the capital needed for growth or operational improvements.
For lenders, term loans offer a clear structure for repayment, reducing the risk of default. For borrowers, they provide an alternative to diluting ownership through equity financing. Additionally, term loans often come with competitive interest rates, making them a cost-effective option for businesses.
Understanding a term loan through an example
Imagine a restaurant owner wants to renovate their space and expand their seating capacity. They apply for a $100,000 term loan with a repayment period of five years and an annual interest rate of 5%. The lender approves the loan, and the restaurant owner receives the full amount upfront. The owner repays the loan with equal monthly payments over the five years, covering both principal and interest.
In another example, a technology startup needs $250,000 to purchase servers and other IT infrastructure. The startup secures a term loan with a three-year repayment period. The predictable repayment schedule allows the company to manage cash flow while benefiting from the new infrastructure.
An example of a term loan clause
Here’s how a term loan clause might appear in a loan agreement:
“The Borrower agrees to repay the Loan Amount of [Insert Amount] to the Lender in equal monthly installments of principal and interest over a term of [Insert Number] years, beginning on [Insert Start Date]. The Loan shall bear interest at the rate of [Insert Interest Rate] per annum, with payments due on the [Insert Day] of each month.”
Conclusion
A term loan is a practical and widely used financing tool that allows businesses to access the capital they need for growth and development. With predictable repayment terms and competitive interest rates, it offers a structured and manageable way for companies to invest in their future. Including a clear and detailed term loan agreement ensures that both borrowers and lenders understand their rights and obligations, fostering trust and financial stability.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.