What is a Term Loan?

A term loan is a lending arrangement that provides a borrower with a fixed sum of cash. In exchange, the borrower must repay the loan via a fixed number of installment payments over the term of the loan. This type of loan is typically for a period of longer than one year. The intent behind a term loan is usually to provide a business with the funds to acquire cash-generating assets (such as machinery or inventory) that can then be used to pay back the loan. Term loans are frequently collateralized by some or all of the assets of the borrower. Other term loans include a balloon payment at the end of the loan term, which increases the risk of nonpayment for the lender.

Advantages of a Term Loan

The use of a fixed number of installment payments reduces the risk of nonpayment for the lender, since the loan balance is gradually reduced over time. Also, if collateral is involved, then the lender’s risk is extremely low, especially after the loan balance has been reduced by a number of periodic payments.