Term Loans: Types, Benefits, and How They Work

Term loans are essentially loans for a fixed loan amount that must be repaid by the borrower over a pre-determined term in instalments. Term loans can be very desirable financial aid for individuals and businesses needing access to significant funds on an urgent basis. They are structured, fixed-duration loans that are ideal for funding financial objectives like business growth, purchasing machinery, or meeting personal financial needs.

In this guide, we will explore the answer to questions like what a term loan is, how it works, what the different types of term loans are, and why they can be the right fit for your financial needs. Read on!

What is a Term Loan?

A term loan is a type of loan where you get sanction for a lump sum of money and repay it over a specific period in equal instalments. The instalment payments include the interest as well as the principal loan amount. When you're applying for a term loan, lenders will determine the maximum amount, rate of interest, tenure, and repayment cycle before granting you the loan.

In other words, term loans grant access to immediate funds for a specific use and permits repayment in an organised manner.

Key Features of a Term Loan

To define a term loan, we must first understand its purpose and features. Term loans cater to the requirements of individuals and businesses and provide a structured way of borrowing and repayment.

Here are some of the key features of a term loan:

• Fixed Loan Sum: Compared to an overdraft or credit card, where you utilise funds according to your need, a term loan provides you with the entire sanctioned amount all at once. A fixed loan amount also includes fixed Equated Monthly Instalments (EMIs), helping you plan your finances well.
• Fixed Tenure: There is a pre-determined repayment term in a term loan, which can range from a few months to a few years. It is up to the borrower to opt for a short-term, medium-term, or long-term tenure based on their needs.
• EMI Repayment: Borrower can make the repayments for term loans in EMIs that pay back both interest and principal. It facilitates better planning, as you know well in advance how much you need to pay every month.
• Interest Rates: Interest rates on term loans might be either fixed or variable. A fixed rate gives you predictability as your EMI stays the same for the entire duration of the loan. Floating interest rates, on the other hand, fluctuate in response to market conditions, which could affect your loan tenure or EMI.
• Secured or Unsecured: Term loans can be secured against collateral (property or machinery) or unsecured, depending on eligibility.
• Purpose-Driven: Term loans are availed for a specific purpose, like business growth, personal needs, or asset acquisition.

Types of Term Loans

Term loans are of different types based on the tenure of the loan. Here are some of the most common types of term loans in India:

1. Short-Term Loan

• Repayment tenure: Mostly within 12–18 months
• Best suited for: Covering working capital requirements, short-term expenses, or unexpected financial requirements

2. Medium-Term Loan

• Repayment period: Within 1–5 years
• Best suited for: Business development, enhancement, or acquiring new machinery

3. Long-Term Loan

• Repayment period: More than 5 years
• Best suited for: Investment funds, such as property or high-scale infrastructure construction

Benefits of Term Loans

Term loans are the most sought-after borrowing options in India for borrowers looking to get funds urgently, as they balance between quick disbursal and a structured repayment schedule. Below are some of the key advantages of term loans:

• Large Loan Amounts Available: For machinery purchase, business expansion, or any other personal spend, term loans offer a large sum of money that may not otherwise be readily available.
• Fixed Repayments: EMIs are fixed (in the case of fixed interest-rate loans), and it is simple to budget your outgoings every month. This stability lowers your financial stress.
• Flexibility of Tenure: You have an option to choose from a wide range of loan tenures, considering your income and repayment capacity.
• Encourages Discipline: Through regular payment, you can become financially disciplined. This improves credit behaviour and even raises your credit score.
• Affordable Option: In comparison to credit cards or overdraft facilities, term loans have lower interest rates, making them a cost-effective borrowing option.

Read Also: Which is the Better Personal Loan - Term Loan or Overdraft?

Eligibility Criteria for a Term Loan

Now that you understand what a term loan is, it's also important to be aware of the eligibility criteria for a term loan in India. Even though the term loan differs from lender to lender, here is a brief overview of minimum eligibility criteria for a long-term loan with most lenders:

Factors to Consider Before Taking a Term Loan

If you're thinking of applying for a term loan, there are some factors that you need to consider before you apply. Here are some of them:

1. Interest Rate: Always examine the interest rate carefully. Even a small difference in the interest rate can create a big difference in your savings over the term of the loan. Conduct proper research and get multiple quotes from various lenders to obtain the best deal.
2. Loan Tenure: Your repayment tenure should be aligned with your income stream and financial needs. With a shorter tenure, your EMIs will be higher, and you'll have to pay much less interest overall. Whereas with a long tenure, EMIs will be lower, and you'll have to pay much higher interest overall.
3. Repayment Capacity: Analyse your present and future income honestly. Make sure EMIs are integrated smoothly into your financial plans without overburdening your other financial commitments.
4. Hidden Fees: Prepayment charges, default charges, and processing fees may be levied, adding to the cost of borrowing. Request your lender to clearly explain all the applicable fees.
5. Purpose of Loan: Specify the reason for which you are borrowing the funds. For business expansion, asset acquisition, or household consumption, specifying the purpose enables you to choose the correct type of term loan and avoid unnecessary borrowing.
6. Reputation of the Lender: Along with selecting the right loan terms, it’s important to choose a reliable lender, one that ensures transparency, provides excellent customer service, and processes applications quickly.

To Conclude

A term loan is one of the best and most flexible ways of borrowing funds for urgent needs. They offer you a lump sum for a fixed period. However, before you apply for a term loan, choose a trustworthy lender, compare interest rates, and select loan terms that best suit your needs.

FAQs

Is prepayment of a term loan allowed before the end of the repayment period?

Yes, most lenders let you make prepayments. However, they may charge you a small penalty.

Are term loans always secured?

No. It depends on the lender. Some lenders provide unsecured term loans based on the creditworthiness of the borrower.

How is my EMI calculated for a term loan?

Your EMI will depend on the amount of the loan, the rate of interest, and the tenure. You can calculate your EMI using a term loan EMI calculator.

Can a business use a term loan for multiple purposes?

Yes, unless the term loan is approved for a specific purpose, the business can use the funds as per its requirements.

What if I default on a term loan EMI?

Defaulting on an EMI can result in late fees, increasing the cost of borrowing and negatively affecting your credit score.