Term Loans: How They Work and How to Use Them

Businesses use term loans for a huge variety of purposes, from key asset purchases or investments to covering tax bills or easing cash flow issues. However, there are various forms of term loans, some more suitable than others for different types of businesses. 

In this article, we explore the types of term loans available, how they work and the key suitability considerations when deciding which finance solution is right for you.

What is a business term loan?

A term loan is a type of financing where a business borrows a lump sum of money from a lender, which is then repaid with interest over a fixed period. 

• Term loans are typically used for specific investments, such as purchasing machinery, expanding premises, or financing long-term projects. 
• The key feature of a term loan is its repayment schedule, which can vary from a few months (short-term loans) to several years (long-term loans), depending on the loan agreement.

Depending on the term, lenders may set different conditions, such as asking for collateral or a personal guarantee, and interest rates can vary according to the loan’s length and capital amount.

What is the difference between a term loan and a business loan?

While the terms term loan and business loan are often used interchangeably, they’re not quite the same. A business loan is a broad category of financing that can have various lending models and repayment structures. In contrast, a term loan specifically refers to a loan that is repaid over a fixed period with a pre-agreed repayment schedule, typically through regular instalments.

Business loans can take various forms beyond term loans, such as merchant cash advances (where businesses repay funds as a percentage of future card sales until the full amount, including fees, is recovered) or invoice financing (where the lender is repaid once the customer settles their invoice).

What kind of business uses term loans?

Term loans are often used by established businesses that need to make significant investments without drawing on their cash reserves. The key advantage is their flexibility – unlike forms of financing tied to specific investments, such as equipment finance or inventory finance.

Whether you’re a retailer looking to stock up on seasonal inventory or a manufacturer needing to upgrade your equipment, a term loan provides the capital required while allowing you to spread the cost over time.

‍

How do term loans for businesses work?

Term loans cover several lending products with fixed repayment schedules, offered by high street banks, financial institutions and alternative lenders.

While different forms of term loans have varying eligibility criteria or lending limits, most work in a similar way. Below, we outline the key aspects to understand and the different types of term loans you can use:

Repayment terms and flexibility

Repayment schedules for term loans can be customised to fit your company’s cash flow needs. 

Typically, term loans see businesses repay the funds borrowed in monthly instalments. However, finance lenders may give you the flexibility to pay in a different periodic structure, depending on your needs. One of the main factors is how long you want the funds for and how much you need to borrow.

It’s also important to understand the conditions around early repayment – paying off your loan early can save you all the interest you would have paid over the whole term. Some lenders, such as iwoca, allow you to repay early free of charge. Plus, you may be able to agree on a repayment holiday with certain lenders (usually for businesses with inconsistent cash flow).

‍

{{calculator-cta="/components"}}

‍

Loan fees and charges

Depending on the term loan lender, your business will be subject to a variety of fees/charges, including arrangement fees and security fees, late payment penalties and, in some cases, early repayment charges.

Then there are the interest fees, which you’ll pay on the money you’ve borrowed (and have left to repay) throughout the loan period. Some loan providers like iwoca can save you money on interest fees by only charging interest on funds you actually draw down (like a line of credit), so check the format of the loan offered.

Interest rates can widely differ from lender to lender, and loans have fixed or variable rates. Here’s a brief overview:

• Fixed interest rates: The interest rate remains the same throughout the loan term, providing predictability in repayment amounts. This is ideal for businesses that prefer stability in their financial planning.
• Variable interest rates: Here, the interest rate can fluctuate based on market conditions, which means your repayments might vary. While this option can be riskier, it may result in lower interest payments if rates decrease.
  ‍

Different types of term loans

The main considerations around what type of term loan to choose are whether you need a loan for a matter of a few days, weeks or months or longer-term needs, such as several years, and if you want/need a secured loan or an unsecured loan. 

Typically, unsecured loans are for short-term funding needs, with secured loan providers usually offering larger amounts for longer repayment periods.

For an easy way to compare the main components and pros/cons of the different types of term loans, see the below comparison table:

‍

Example use cases for term loans used by UK businesses

Term loans can be used in various ways, but here are a few common scenarios in which a business might use a term loan:

• Purchasing new assets and equipment: Terms loans enable businesses to spread the cost of acquiring new business assets, from general office equipment to vehicles or machinery.
• Accelerating growth: An injection of capital can help you fund strategic projects, increase your workforce or invest in product development and market expansion. This could also involve upgrading premises.
• Plugging temporary cash flow gaps or shortfalls in funding: Short-term loans can be a lifesaver for businesses in difficult times, when tax bills are due or for reaching a funding target for a particular purpose. 
• Ramping up seasonal activities: If you need new inventory or want to boost promotional activity during peak sales periods, a term loan can give you fast access to funds to repay after increased revenue comes in. 

Term loan providers

There are countless term loan providers in the UK offering widely varying amounts, lending periods and interest rates, so how do you know where to start? The main things to consider are how fast you need the funds, how much you need and the level of flexibility and risk you are prepared to accept. 

Once you know these answers, you can judge the suitability of different term loan providers. 

• Term loans from high street banks and traditional lenders: You may get access to higher amounts of capital and potentially better rates, but eligibility criteria are often stricter, and applications take longer than when using alternative finance lenders. 
• Term loans from private and digital lenders: Applications can usually be done entirely online with streamlined approvals, meaning faster access to funds. Loans are primarily unsecured, meaning no requirement to use assets as collateral. 
  ‍

Advantages of term loans

Term loans are one of the most common forms of lending for a reason: they help businesses access finance in an easy-to-understand, easy-to-manage way.

• Predictable repayment schedule: With a fixed interest rate, term loans offer predictability, allowing you to budget more effectively. You’ll know exactly how much you need to repay each month, which helps with long-term financial planning.
• Flexible use of funds: Unlike some other types of financing, term loans can be used for a wide range of business purposes. Whether you’re looking to expand, purchase equipment, or even refinance existing debt, a term loan provides the flexibility you need.
• Interest rates and tax benefits: Interest on term loans is often tax-deductible, which can reduce your overall tax liability. Additionally, secured term loans generally offer lower interest rates compared to unsecured loans, making them a cost-effective option for many businesses.
  ‍

Disadvantages of term loans

While term loans have many advantages, there are also some potential drawbacks to consider:

• Collateral risks: For secured term loans, your assets are at risk if you’re unable to make repayments. This could lead to the loss of critical business property, which might hinder your operations.
• Interest rate fluctuations: If you opt for a variable interest rate, changes in market conditions could lead to higher repayment costs, putting pressure on your cash flow.
• Managing debt: Taking on a large term loan can significantly increase your business’s debt burden. It’s essential to ensure that your revenue projections support the repayment of the loan, even in challenging times.

‍

How to apply for a term loan

When applying for a term loan through a high street bank or traditional lender, it can take much longer than with a digital lender. With a bank, you may need to speak with a specialist over the phone, meet more stringent eligibility requirements and provide a lot of documentation. Also, banks tend to offer secured loans, which means submitting details of assets used as collateral.

Applying for a term loan with iwoca is quick and easy. Simply apply online in minutes, without needing heaps of paperwork. Our automation-powered approvals enable decisions within 24 hours, and successful applicants can get access to funds on the same day.

Get a business loan faster with flexible terms using an iwoca Flexi-Loan

iwoca is one of the UK’s leading providers of flexible business loans, which can be used for a wide variety of operational and strategic purposes, helping SMEs to improve cash flow management and reach their growth ambitions.

Our Flexi-Loan solution is tailored to your needs and cash flow, and you only pay interest on the funds you draw down. You can borrow £1000-£1 million for a few days, weeks, or as long as 60 months.

{{business-funding-on-your-terms="/components"}}