Meaning:
It is a loan from bank which has a floating interest rate, the total amount of which must be paid off within a certain period of time. An example of a term loan is a loan to a small business to buy fixed assets, such as a factory, in order to operate. The length of a term loan varies between one and 10 years, depending on the loan agreement. It is a loan with a maturity date but no amortization. One pays the interest monthly, quarterly, or annually, as required by the lender, but the principal is not due until maturity. Term loans of short duration, usually less than one year, may be set up as single pay loans. In that case, principal and all accrued interest are paid at maturity.
In short a term loan is a loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate and almost always matures between one and 10 years.
Nature Of Term Loans
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A term loan can be further divided as amortizing loan or a bullet loan. A term loan of the amortizing nature is categorized as term loan A and the later is called as term loan B.
Term loan A (TLA)
It is a type of term loan wherein the principal amount is recovered along with the interest due to which your loan principal decreases over the life of your loan, this process of spreading the principal amount over the life of your loan is termed as amortization. In this case, a portion of your payment is applied towards reducing your principal and another portion of your payment is applied towards paying the interest on the loan. It is unlike revolving credit in that once the borrowed amount is paid back to the lenders, the borrower cannot reborrow the money under the TLA facility.
Term loan B (TLB)
A form of high yield loan that emerged in the early 1990’s in contrast to the term loan A. It differs from term loan A in this it has a bullet rather than amortizing maturity, and usually has a longer maturity. A bullet loan is a loan where a payment of the entire principal of the loan and sometimes the principal and interest, is due at the end of the loan term. The investors in B term loans are mainly institutions rather than banks, making it the original class of “institutional” term loans by contrast with the “pro rata” term loan A. It was soon joined by other classes of term loans such as C and D, which have progressively longer maturities. All these term loans, however, rank equally in terms of seniority.
The institutional term loan tranches :
In contrast to payments on the TLA amortization payment on ITL are usually more heavily back loaded or come as a bullet payment at final maturity. Institutional tranches are usually named in alphabetical order (term loan B, C, D and so on depending upon the number of tranches.) For example TLA might be 5 years, TL B might be 6 years, TLC might be 7 years and so on.
Payments on these tranches are usually back-loaded, with interest payments constituting the majority of cash flows in early years. Tranches are designated B, C, D etc. on the basis of maturity. Each successive tranche has maturity later than the previous tranche. For each additional year until maturity, spreads are generally 25 to 75 bps wider.
Reasons and merits
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T[/b]erm loans are offered by the high street banks and their popularity has increased for a number of reasons, not least their accessibility, which is of importance to smaller entities. A term loan is for a fixed amount with a fixed repayment schedule. Usually the interest rate applied is slightly less than for a bank overdraft. Here, the lender will require security to cover the amount borrowed and an arrangement fee is payable dependent on the amount borrowed.
Term loans have the following merits:
They are negotiated easily and quickly:
Term loans can be easily accessed from any banks or financial institution provided that there are no cash flow problems identified until recently and a quick but significant fix is needed.
Flexible repayments:
Banks may offer flexible repayments. High street banks will often devise new lending methods to suit their customers; for example, no capital repayments for, say, two years, thus avoiding unnecessary over borrowing to fund capital repayment.
Variable interest rates:
This may be important given the uncertainty exist with interest rates.
Relationship management:
A dedicated Relationship Manager to cater to your business needs
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Term Loans facilitate the borrower to raise a stipulated amount one time and plan the business expenditure or investment or purchases on his or her own.
Term Loan is normally preferred by small and medium scale businesses to meet the needs of working capital or to buy assets or infrastructure which is required to run the business on day to day basis. It may include purchase of machinery or buying an office or workshop premises
The maturity period or term is between 1 – 10 years.
The term Loan can be availed to
Purchase of Fixed Assets
The term loan can be used to purchase fixed assets like premises, plant & machinery etc. The usage or performance of assets increases the business performance and hence the profit and makes the repayment of the loan easier. Even the term loan is settled the assets procured continue the productivity as asset life span is certainly longer than the term loan span. If a premises is purchased then the value of premises is always appreciated and in that case the business leverages higher value of premises which further can be used to raise funds for business expansion or diversification.
Switching of Higher Interest Loans
Many a time’s business owners opt to raise business loans at higher rate of interest. Such loans are processes and sanctioned faster but result in heavy burden interest. This interest payment becomes a fixed monthly expenses and starts leaking the profit. To arrest the growing rate of interest and penalties the higher interest loan can be switched to lower rate of interest loans or term loans. This way a borrower reduces the growing burden of interest on business loan and can save a considerable amount of money. It also benefits in maintaining the credit rating as the borrower closes one loan liability and opens another in form of term loan with lower rate of interest and easier repayment conditions
Mortgage Term Loan
A Term Loan can be availed by mortgaging a kind of security like home, office premises etc. This type of loan is borrowed for longer period of time that is 10, 15 or 20 years. The repayment of the principal amount and interest may be fixed in nature or it may vary over the course of repayment. The borrower may avail the revised rate of interest later and may be benefited by saving in interest.
Term loans for small businesses
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When most people think of a typical bank loan, they think of a term loan. A term loan has a fixed length as mentioned before, often with amortization of principal. Amortization is the repayment of a loan with periodic payments of both principal and interest calculated to pay off the loan within a certain amount of time.
Short-term loans, typically lines of credit, working capital loans, or accounts receivable loans, usually reach maturity within one year or less. Long-term loans usually last one to seven years, although it is not uncommon for long-term loans to mature after 10 or 20 years.
Term loans sometimes require collateral to secure the loan, and loan amounts typically start at $25,000, with an industry average of 1 percent in fees. The approval process for term loans is extremely thorough, so be prepared. Applicants must demonstrate strong character, good credit history, competence in and commitment to their business, and sufficient collateral and working capital. Just as with any other type of loan, banks take into consideration the same factors as with term loan applications. If you qualify, rates on term loans are generally lower than those of other types of loans.
Long-term and intermediate loans are most appropriate for established small businesses that can demonstrate the ability to make the required interest and principal payments. If you are thinking about financing equipment, make sure that you can claim ownership benefits on your taxes — comparing the overall cost benefits with leasing options is a good idea. Banks require complete financial statements for large loans of $100,000 and above.
Loans with longer maturities are designed for borrowers making large business purchases such as equipment, machinery, real estate, and furnishings. Long-term loans also help business owners fund construction projects, buy vehicles for business use or purchase existing businesses. An advantage to loans with longer timeframes is they can help businesses manage cash flow during slow times.
One thing to take into account when considering a term loan is that banks often limit the amount of additional liabilities a business can assume in addition to the loan. This includes employees' salaries, which could affect your ability to attract qualified workers. In some cases banks will require borrowers to set aside a set percentage of profits to repay the loan.
Conclusion
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Problems of term loans with reference to India and suggestions[/b]