Term Loan – Fascinating Term Loan Tactics That Can Help Your Business Grow
The term loan is the major sources of intermediate financing for small as well as a large corporation. Term loans are particularly important to medium-sized firms; those that have becomes too big to obtain all of their financings from their commercial bank but are not large enough to issue publicly-traded bonds and debentures. The typical term loan is one that is said to be “self-amortizing”. That is, it made up of a series of equal payments, with each payment being comprised of both interest and principal (just like a fixed rate mortgage on a home). Intermediate-term loans are typically used to finance equipment purchases, expand business operations or increase working capital.
Suppliers of Term Loan Doesn’t Have to Hard: Read These 5 Tips
There are various sources from which firms can get the term loans, such as Commerical bank, Pension Funds, Insurance Companies, Equipment Manufacturers and etc.
Among the various available suppliers, commercial banks are considered a primary and important source of term loans. The majority of commercial banks, as well as other financial institutions (Saving and Loan Associations), are actively involved in lending term-loan to the business organization. Most of the term-loan is secured by collateral represented by fixed assets (land building, vehicles, plant and machinery and etc.). The term-loan provided by this type of commercial banks are repayable in periodic installments (I.e. Monthly, Quarterly, semi-annually or yearly) and consists of both interests as well as the principal amount. The interest rate is generally higher in term-loan than the prime rate. The interest rate can be set in several ways:
- A rate that will remain fixed over the life of the loan
- A variable rate that varies in keeping with the changes in the prime rate.
- A ceiling or a flour rate that will fluctuate within the rent.
Revolving Credit represents a formal agreement between borrower and lender specifying the maximum funds that the lender will make available. Once the firm sets the revolving credit agreement with financial institutions, it can use the required volume of funds when necessary. The actual revolving credit is short-term but the company may renew them or borrow additionally up to the specified maximum throughout the direction of the commitment.
Under the revolving line of credit, the bank is legally committed to provide loan to the company up to the pre-determined credit limit specified in the agreement. Therefore, under this loan agreement, the bank requires the borrower to pay a commitment fee on the unused portion of the fund.
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Insurance companies and other institutional lenders may extend intermediate-term loans. Insurance companies typically accept loan maturity dates exceeding 5 years, but their rate of interest is often higher than that of bank loans. Insurance companies do not require compensating balances, but usually, there is a payment penalty, which is typically not the case with a bank loan. You may take out an insurance company loan when you desire a longer maturity range.
Employees’ pension fund may also provide access on intermediate-term financing on the basis of secured loans. Such loans are usually secured by mortgages on the property. Although the terms and conditions of the lending may vary across pension funds, they are all most similar to the loans provided by insurance companies and other financial institutions.
When a firm procures a loan to finance new equipment, it may use the equipment itself as collateral for an intermediate term-loan. These loans are called equipment financing loans. Equipment financing loans are commonly made for readily marketable equipment. Equipment financing may be obtained from banks, finance companies, and manufactures of equipment.
There are two primary security instruments used in connection with equipment financing loans, the conditional sales contract, and the chattel mortgage.
****************** Conditional Sales Contract **************
When a conditional sales contract (sometimes called a purchase money mortgage) is used in an equipment financing transaction, the seller title until the buyer has made all payments required by the financing contract. The conditional sales contract is used almost exclusively by equipment sellers. At the time of purchase, the buyer normally makes a down payment to the seller and issue a promissory note for the purchase price. The buyer then aggress to make a series of periodic payments (usually monthly or quarterly) or principle and interest to the seller until the note has been paid off. When the last payment has been made, the title to the equipment passes to the buyer. In the case of default, the seller may responses the asset.
*************** Chattel Mortgage ***************************
A Chattel Mortgage is a lien on property other than the real state. Chattel mortgages are most common when a commercial bank or sales finance company makes a direct equipment financing loan. It involves the placement of a lien against the property by the lender. Notification of the lien is filed with a public office in the state where the equipment is located.
What Everyone Ought to Know About Features of Term Loan
The Term Loan agreement has its specific features which make it unique as compare to other types of loan. The main features of term-loan are as follows:
- Fixed Maturity: Term loan has a fixed maturity period, above one year, within the entire loan must be repaid along with the interest. Generally, term-loan last for 10 years but also some of the term-loan has a longer period, above 10 years.
- Direct Negotiation: Term loans require direct negotiation with the lender. This is private placement as against the bonds and debentures that are privately placed.
- Tied up with Collateral: Most of the term-loans are secured by certain assets. This asset may be represented by fixed assets such as land and building, vehicles and etc. Or current assets.
- Restrictive Covenants: The lender often adds restrictive covenants to the loan agreement in order to make the lender safe.
- Repayment Schedule: The main characteristic that makes a term loan unique as compared to other long–term debt is its repayment schedule. Term loans have a fixed repayment schedule. Under term-loan, fixed installments are repaid at a fixed interval over a specified number of periods. This fixed installment consists of both interests as well as the principal amount.
Advantage and Disadvantages of Term Loan
|Advantage of Term Loan||Disadvantages of Term Loan|
|The cost of term loans is lower than the cost of equity capital.||The interest and principal repayment are obligatory payments.|
|Term loans do not result in dilution of control, as lenders do not have the right to vote.||They increase the financial the risk of the firm. This turn tends to raise the equity of cost capital.|
|Term loans are especially more suitable for those firms who are beyond the access of using line-of-credit and issuing securities like commercial paper.||Term loan contracts carry restrictive covenants that may reduce managerial freedom.|