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Term loan is also called as demand loan. A term loan is a funding from a bank for an amount that is to be repaid as per EMI (Equated Monthly Instalment) schedule. The interest rate can be either fixed or floating rate as per the choice of the borrower. Term loan can be extended for variety of purposes including setting up of business, working capital expense, purchase of equipment, overhaul of plant and machinery etc. The loan tenure can range between 1 year to 3 years to 10 years. The tenure may be extended on a case to case basis upto 30 years. Also, shorter-term credits can be extended for companies which need funds but do not qualify for longer term credit. Term loans are extended for both green field and brown field projects.
About Term Loan
Term loans can be categorized based on the tenure for which they are borrowed. The categories in general parlance are –
The loans are for less than a year or upto 18 months. These companies may also be ones that do not qualify for longer tenure of credit.
The period for such loans could vary from 2 year – 5 years. These loans could be critical for company’s cash flow. Typically, companies which are new and have established afresh may need such intermediate term loans.
These loans can run anywhere between 5 years – 10 years. The company’s assets are offered as collateral. The repayment could be either monthly or quarterly as per the company’s profit or cash flow recognition.
Short-term loans and intermediate loans are called balloon loans as they come with balloon payments. The final instalment is higher than the previous loan instalments. Since the instalments swell towards the end of the loan tenure, it is called as balloon loans.
The key features of term loans are as follows –
There are advantages and disadvantages for a borrower who opts for term loan.
The factors that affect the eligibility to avail term loan are -
The interest on the term loan can be either floating rate or fixed rate. Normally, the borrower has the discretion to choose between the two.
Floating rate of interest :
The interest rate pertaining to the loan fluctuates with the market interest rate and economic conditions of the market. This inturn causes the instalment amount to change over the tenure. Typically, banks revise the rate of return every few years or align themselves with market subject to severe or drastic change thereof.
Fixed rate of interest :
The interest rate pertaining to the loan, in this case, remains fixed over the tenure of the loan. The installment amount remains constant over the tenure. The rate of interest is decided upon at the time of loan sanction.
The borrower can choose the type of interest rate based on the market cycle. Typically, when the interest rates are high, one chooses the floating rate of interest, in the anticipation that the rates may moderate over the next few years. When the rates are lying low, it makes sense to lock-in with fixed rate of interest. Also, typically, fixed rate of interest is chosen for short-term loans and for long-term loans floating rate of interest is preferred.
Term loans are ideal for any asset purchase, business expansion or asset overhaul, the terms can be negotiated favorably depending on the credit history of the business.
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