Business Term Loans Explained
A practical, plain-English guide to how term loans work, what lenders look for, and how to decide if fixed-payment financing fits your business.
What Is a Business Term Loan?
A business term loan is a lump-sum amount you borrow up front and repay over a set period (the “term”) with fixed, scheduled payments. The main attractions are predictability and structure: you know your payment amount, payoff date, and total cost if you keep the original schedule.
How Do Term Loans Work?
While programs and lenders differ, most term loans share the same workflow:
- Apply & document your business, owners, revenue, and plans for the funds.
- Underwriting reviews credit, cash flow, collateral (if any), and industry risk.
- Approval & terms: loan amount, interest rate (or factor rate), fees, and repayment schedule are offered.
- Funding arrives as a lump sum (often to your business bank account).
- Repayment is made in fixed installments (weekly, bi-weekly, or monthly) until the balance is fully paid.
Fixed payments help with budgeting and cash-flow planning, especially compared with variable revolving credit.
Because the loan amortizes, more of your payment goes to principal over time, steadily building equity in the asset you financed.
Common Types of Term Loans
| Type | Typical Term | When It’s Used |
|---|---|---|
| Short-term loan | 6–24 months | Quick needs, small equipment, bridging inventory or seasonality |
| Medium-term loan | 2–5 years | Renovations, vehicles, larger equipment, expansion |
| Long-term loan | 5–10+ years | Major build-outs, acquisitions, heavy equipment |
| SBA term loan (e.g., 7(a)) | Up to 10 years for working capital/equipment; up to 25 years for real estate | Lower payments and longer terms if you meet eligibility and can wait for the timeline |
Rates, Fees & Total Cost
Term loans may quote an APR (annual percentage rate) or a factor rate (common on short-term products). APR includes interest plus certain fees; factor rates multiply the amount you borrow to show total payback.
Typical Costs You May See
- Interest/APR: varies by lender, credit strength, DSCR, collateral, and term length.
- Origination fee: often 1–5% of the loan amount.
- Packaging/underwriting fees: more common with SBA loans.
- Prepayment policy: some loans have no penalty, others include a prepayment fee or “interest add-on.”
What Do Lenders Look For (and How to Qualify)
Underwriting varies, but four pillars show up nearly everywhere:
- Cash flow & DSCR: Lenders want to see that operating cash covers debt payments with a cushion. A DSCR of ~1.20× or higher is commonly targeted.
- Credit profile: Personal credit (and sometimes business credit) helps predict repayment behavior and pricing.
- Time in business & revenue trends: More operating history and steady (or growing) revenue reduce risk.
- Collateral/guarantees: Secured loans and personal guarantees are common for larger amounts or longer terms.
Steps to Strengthen Your Application
- Prepare financials (P&L, balance sheet, bank statements) and keep deposits consistent.
- Improve DSCR by trimming non-essential expenses, raising prices strategically, or paying down other debt.
- Build business credit and correct errors on your reports.
- Show a clear, practical use of proceeds with conservative projections.
Term Loan vs. Business Line of Credit
| Term Loan | Line of Credit | |
|---|---|---|
| Structure | Lump sum, fixed payment schedule | Revolving—draw, repay, draw again |
| Best for | One-time, larger projects or assets | Short-term working capital swings |
| Predictability | High—payment and payoff date known | Variable—payment changes with balance |
| Cost | Can be lower for strong borrowers, especially with SBA terms | Pay interest only on what you use; may carry annual/draw fees |
Smart Uses—and What to Avoid
Smart Uses
- Revenue-generating equipment or vehicles
- Renovations that increase capacity or efficiency
- Opening a second location with a proven model
- Refinancing short-term, high-cost debt (when total cost improves)
Think Twice
- Covering permanent cash flow gaps without a plan
- Speculative projects without realistic projections
- Using long terms for expenses that will be gone in months
Application Checklist
Having documents ready speeds up underwriting. A typical checklist includes:
- Driver’s license (owners) and basic business info (EIN, entity type)
- Business bank statements (most recent 3–6 months)
- Tax returns and/or financial statements (P&L, balance sheet)
- Debt schedule (current loans/leases with balances and payments)
- Use-of-funds description and quotes for any equipment/projects
Business Term Loans: FAQs
1) What credit score is usually needed?
It varies by lender and product. Prime bank/SBA options prefer stronger profiles, while alternative lenders may approve lower scores at higher cost and shorter terms. Lenders evaluate the full picture—cash flow, time in business, collateral, and DSCR.
2) Are term loans always secured?
No. Many small loans are unsecured but may still require a personal guarantee. Larger amounts and longer terms are more likely to be secured by business assets or specific equipment.
3) Can I pay off early?
Some loans allow early payoff with interest savings; others have prepayment penalties or use interest add-on methods. Always read the note carefully before signing.
4) How fast can funds arrive?
Non-SBA loans can fund in days. SBA loans usually take longer due to documentation and government steps, but offer longer terms and potentially lower payments.
5) Is a term loan better than a line of credit?
It depends on the use. For a one-time investment that pays back over years, term loans shine. For recurring, short-term needs, a line of credit offers flexibility.