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

From the perspective of the lender, there are several advantages to issuing term loans, which are as follows:

Lower risk of nonpayment. 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. This is different from a balloon payment arrangement, where the borrower must pay back the entire amount of the loan on its maturity date.
Collateralization. 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.

There are also several advantages to term loans from the perspective of the borrower, which are as follows:

Tax deductible. Depending on the situation, the interest paid on a term loan may be tax deductible.
Credit score enhancement. Making timely loan payments is a good way to boost your credit score, since it shows that you are a responsible borrower.