Term loans

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Page written by Chris Godfrey. Last reviewed on October 30, 2024. Next review due 2025.

Term loans for businesses can be fast and simple to obtain and may let you pay the money back over many years. Often available with borrowing costs that are cheaper than other types of business finance, term loans can also be used for almost any purpose. No wonder they’re Nigeria’s most common type of business loan.

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What is a business term loan?

With a business term loan, your organisation receives a single, lump-sum cash injection and then you pay it back in regular instalments, plus interest and any fees, over a fixed period of up to 25 years. Instalments may be weekly, monthly or quarterly depending on the type of business you operate.

Some term loans may be unsecured, so you do not provide collateral to protect the lender if you default. Other term loans – typically for larger sums or for riskier businesses – may require security. This means you pledge assets such as property, vehicles or machinery to protect the lender from loss. If your business defaults on the loan, the lender can seize these assets and sell them to recover their money.

Interest rates on unsecured term loans tend to be higher and the amount you can borrow will usually be smaller than you may find with loans where you provide collateral.

What can I use a term loan for?

You can use a term loan for almost any business purpose:

Working capital
Buy plant, machinery, vehicles or property
Marketing activities
New product development
Expansion or acquisition activities
Repay more expensive short-term debt
Pay taxes
And more

How do business term loans work?

Business term loans are quite simple in their basic structure:

You borrow a fixed sum of money (this is called the ‘principal’)
Interest accrues on this sum – typically from the day of funding
The interest rate may be fixed or variable and it may be calculated on the whole principal (flat rate), or it may be calculated on the outstanding balance (amortised). Some term loans may be ‘interest only’ which means you only pay interest on the principal over the duration of the loan and then you pay back the principal in one lump sum at the end of the term. (This is known as a balloon payment).
You make regular repayments – weekly, monthly, quarterly – over the term of the loan, (which can be anywhere from a few months to 25 years). Unless you have opted for an interest-only loan, your payments will be a mix of principal and interest. The sum you repay with each instalment may be fixed, or it may fluctuate depending on how your interest is calculated.
At the end of the term, the loan is paid off. Any collateral you have provided is released by the lender.

What are the different types of business term loans

Although all terms loans have the same basic structure – a lump sum paid back over a fixed period of time – there are also many tweaks and options that can impact the way the loan works:

Short-term loans

Short-term loans are often used as emergency funding to cover unexpected costs, or to capitalise on a sudden business opportunity. You borrow a sum of cash for a short period, usually less than one year. Short-term business loans can be obtained very quickly, but interest rates can be high and the sum you can borrow will usually be smaller than you may obtain with other types of term loan. Collateral may be required.

Intermediate-term loans

Similar to above, but the term of the loan can be anywhere from one to three years. Intermediate term loans are a good option for businesses seeking to buy capital assets, such as machinery, as they still pay off relatively quickly, but usually come with lower interest charges and fees and deliver larger principal than their short-term counterparts. Collateral is often required.

Long-term loans

Long-term business loans can take as long as 25 years to pay back. These types of loans generally provide much larger principal and will typically require the borrower to provide collateral. Long-term loans have the lowest interest rates and are suitable for major financial expenditures – such as buying property or paying for large-scale construction costs.

How to decide if a term loan is right for me

Is a term loan right for your business, or would you be better off with alternative financing, such as a business line of credit, or equipment financing? Here’s how you decide if a term loan is your best funding option:

What am I using the finds for?

Although you can use them to pay everyday expenses, term loans are best when you are using the funds to cover a costly purchase (such as machinery), or for a purchase that has good ROI. If you need cash to fill a gap in your working capital, you may be better off with a business line of credit, invoice financing, or a merchant cash advance.

What will the loan do for my business?

It’s best to use a term loan that will help you generate more revenue or gain more customers. Calculate the potential return on investment. Will the loan improve your profitability or deliver a bump in turnover? If not, refer to the alternative loans suggested above.

Can I afford to make the repayments?

Taking on a loan you can’t afford won’t help your business, it will only increase your problems. Crunch the numbers. Do you have sufficient cash surplus to make the payments every month? If not, a term loan is not for you.

What are the pros and cons of a term loan?

Pros

Lower borrowing costs – term loans often come with lower interest rates than other business lending
Flexible terms – borrow from a few months up to 25 years
Larger sums available – business term loans can provide bigger principal amounts than many other types of business finance
Transparency – you know how long the loan will take to repay, what you will repay, and what your instalments will be from the get-go
Simple application – term loans often have streamlined application processes and may require minimal paperwork
Fast to fund – some term loans can fund in less than 24 hours

Cons

May require collateral – this can be an issue for businesses with few assets
Pay back options can be limited – unlike a line of credit or other flexible financial products, term loans are fixed from the start and if you want to pay them off early, you will usually incur a hefty penalty
Restrictions can apply – many term loans require the borrower to have good credit and to have been in business for a few years. This can create difficulties for businesses with weak credit or a short trading history

How to apply for a term loan

Obtaining the best term loan for your business means preparing in advance:

1. Research lenders

Interest rates and terms and conditions for business term loans can vary significantly, so it makes sense to shop around before settling on a lender. You can do this by approaching banks, credit unions and online lenders one by one, or you can use the services of a loan marketplace that will immediately introduce you to a choice of term loans from different lenders. Some marketplace platforms can also give you advice and help you with the application process. This can be especially useful for borrowers who have never taken out a business term loan before.

2. Check your credit scores

It is common for mistakes to occur on credit reports – both business and personal. Incorrect information could have an adverse impact on your credit scores and your loan application. Check both reports and ensure the details they contain are all correct. If there are errors, get them fixed before applying for a loan.

How to re-build your credit:

If your credit score is poor, it may be worth taking steps to improve it before applying for a business loan. A better score will enlarge your pool of potential deals and may also reduce the interest rate and fees you pay. Unfortunately, despite big promises from the many ‘fast credit repair’ businesses you may see online, there is no quick fix for a poor credit score. It takes time and good financial management to get a poor score back into the good category. Key actions to improve your credit score include:

Pay bills and loan repayments on time
Reduce your debt levels and only apply for credit when you need it
Start to build a credit history – taking out a business credit card is a good place to begin
Keep old credit accounts open, even if you rarely use them – it helps to grow credit history
Move home or business location less frequently – lenders usually like to see at least two years at your current address

3. Review the lender’s requirements

No two lenders are the same. Each will have its own terms and conditions. Make sure you meet all the lender’s requirements and have the necessary paperwork before you apply.

4. Gather your documents

Lenders will need to review your key business information. Having the documentation ready in advance will speed up the processing of your application. Required documents typically include:

Business bank statements – at least the most recent six months
List of assets and liabilities – itemise current debts
Cash flow forecast – 6 – 12 months
Business tax returns – past two years
Current balance sheet
Customer list
Business plan
Use of funds – what you need the loan for

How do I evaluate my term loan offer

Once you receive a loan offer, you need to check the small print to ensure the loan is what you asked for and what you need. Carefully review the following:

Term loan amount – check the amount you’ve been approved for as it may be different from what you requested. If you are offered a lower sum than you asked for you should consider how that amount of funding can impact your business, and whether or not it makes sense given the total ROI.

Rate – the interest rate indicates the current rate of borrowing. The annual percentage rate (APR) is the total annual cost of a loan, including all interest payments, fees, and services charges. The APR reflects the true cost of the loan. Make sure it is affordable and makes economic sense.

APR example: 10% APR on ₦10,000 borrowing means the loan will cost you ₦1,000 per year during the term of the loan. Over three years, the total cost of borrowing will be ₦3,000 if the APR remains constant.

Repayment term (duration of the loan) – is your repayment term realistic? Paying back a ₦250,000 loan over one year will be far more difficult than paying it back over five years. You need a repayment term that is feasible and fits with your income and cash flow. Note that some lenders may let you choose from several repayment plans, including paying off your debt in even amounts (which allows you to budget the cost easily) or increasing amounts (which allows you to pay it off faster and accrue less interest).

Personal Guarantee – lenders often require personal guarantees when granting loans to small businesses. Does your offer demand this? If so, it means you are assuming personal liability for your business’s debt. You must pay if your business cannot. Are you comfortable with this risk?

Fees – fees can vary significantly, so it’s critical to review them carefully. Here are some fees that may be tacked onto your offer:

Origination fee – this is an upfront fee the lender charges to process a new loan
Processing fee – this is a general term for the miscellaneous costs of underwriting a loan that lenders sometimes pass on to the borrower. This cost may also be called an administration fee
Utilisation fee – lenders base this annual fee on the amount of credit actually used by a borrower (in instances where the loan is drawn down in smaller advances). It’s a charge for having the funds available on call
Documentation fee – some lenders charge a documentation fee for filing a loan application
Prepayment penalty – there may be a penalty if you pay your loan off early
Late fee – you will be charged a late fee if you don’t make your payments on time. Late fees usually escalate the later you are with any payment. There may also be fees for sending you official demand letters
Broker’s fee – if you hire a broker to help obtain your loan, you’ll have to pay a fee, usually between 1-3% but could be far higher if your business is in a risky industry
Commitment fee – lenders may charge this fee for guaranteeing a loan in the future. It’s usually a fixed percentage of an undisbursed loan amount and it pays for parking the loan at your convenience
Closing fee – these are the costs of valuing any collateral you provide and establishing the lender’s lien on said collateral.

How much can my business afford?

Lenders will review your ‘income to debt ratio’ when considering your loan application. This means they won’t provide funds if they think you will be unable to pay them back because your total debts are already too high. To improve your chances of success, don’t ask for a bigger loan than you can afford to repay. You can work this out by looking at your monthly cash surplus and calculating how much of that you can put aside for an additional loan repayment. Remember that you must always keep a contingency cash float to cover emergencies or unexpected costs, so you should never allocate all your surplus cash to cover extra loan payments.

Get started with Swoop

No matter if you’re seeking your first business term loan or you’re a seasoned borrower, working with business finance experts can make all the difference when applying for funding. Contact Swoop to discuss your borrowing needs, get help with your application and to compare high-quality term loans from a choice of lenders. Give your business the financial boost it deserves. Register with Swoop today.

Written by

Chris Godfrey

Chris is a freelance copywriter and content creator. He has been active in the marketing, advertising, and publishing industries for more than twenty-five years. Writing for Barclays Bank, Metro Bank, Wells Fargo, ABN Amro, Quidco, Legal and General, Inshur Zego, AIG, Met Life, State Farm, Direct Line, insurers and pension funds, his words have appeared online and in print to inform, entertain and explain the complex world of consumer and business finance and insurance.

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