Businesses often need money to grow, buy equipment, or make expansion plans. This is where a term loan comes in. If you want to reach your business goals in a planned way, it is very important to know how term loans work.
A term loan is a fixed amount of money borrowed from a bank or financial institution that you repay over a predetermined period through regular installments.
Term loans are better for big business investments than short-term credit options because they give you more money and more time to pay it back.
Let’s understand everything about term loans in detail.
What is a Term Loan: Meaning and Definition
A term loan is a financial product where a borrower receives a lump sum of money and repays it over a fixed period, typically ranging from one to ten years. The repayment happens through regular monthly EMI installments that include both principal and interest components.
Term loans are used by people and businesses for a number of things, such as buying equipment, buying property, growing their business, or paying off debt.
Predictability is the best thing about such loans. You know exactly how much you have to pay each month and when the loan will be paid off.
How Does a Term Loan Work: A Step-by-Step Process
Understanding the mechanics of a term loan helps you prepare better when you decide to apply. Here’s how the process unfolds from start to finish.
Step 1: Application
You submit an application to the lender detailing the loan amount you need, the purpose of the loan, and your repayment capacity. Banks and NBFCs ask for this information to understand your borrowing intent and financial situation.
Step 2: Evaluation
The lender reviews your credit history, financial statements, and sometimes your collateral (if required). This evaluation determines whether you qualify for the loan and at what interest rate. Your credit score, business turnover, and debt-to-income ratio all play a role here.
Step 3: Approval and Disbursement
Once approved, the lender disburses the entire loan amount as a lump sum directly to your account. You don’t receive this money in installments, it comes as one payment that you can use immediately.
Step 4: Repayment
From the month after disbursement, you start making monthly EMI payments. Each EMI is calculated using a specific formula that ensures you repay both the principal and interest over the loan tenure.
Step 5: Closure
When you’ve made the final EMI payment, the loan is closed. If you provided collateral, it gets released back to you.
What Are the Main Types of Term Loans?
Term loans come in different varieties based on how long you have to repay them. The tenure determines the type, and each type serves different business needs.
Short-Term Loans: For Immediate Needs
A short-term loan has a repayment period of less than one year, typically between 3 to 12 months. These loans are smaller in amount and carry higher interest rates because of the quick repayment timeline and higher default risk for lenders.
When would you need a term loan for a short time? When your business has urgent needs, like buying raw materials, paying bills right away, or dealing with cash flow gaps that happen every season.
Intermediate-Term Loans: For Medium Projects
Intermediate-term loans run from 1 to 5 years. These loans are medium-sized and offer moderate interest rates, making them popular for business expansion and equipment purchases.
These work well when you’re investing in something that takes time to generate returns. Buying new machinery for your factory, launching a new product line, or renovating your office space, these fit the intermediate-term loan category.
Long-Term Loans: For Major Investments
Repayment periods for long term loans can take anywhere from 5 to 15 years or sometimes even longer.
Such loans work best for substantial investments in fixed assets like property, large equipment, or infrastructure development.
What Are the Key Features of a Term Loan?
Knowing the features helps you understand what to expect when you borrow.
- Fixed Loan Amount: You receive a predetermined sum upfront. If approved for ₹10 lakh, you get ₹10 lakh rupees. This amount doesn’t change during the loan tenure.
- Defined Repayment Schedule: Your repayment schedule is fixed from day one. You know exactly when each EMI is due and how long the loan will run. This transparency helps with financial planning.
- Fixed or Floating Interest Rate: You can choose between a fixed rate (stays the same throughout) or a floating rate (changes with market conditions). Fixed rates offer predictability; floating rates might decrease if market rates fall.
- Collateral May Be Required: Larger loans usually need collateral—property, machinery, equipment, or fixed deposits. Smaller loans might be unsecured, meaning no collateral is required.
- Specific Loan Purpose: Term loans typically have a defined purpose. You borrow for equipment purchase, expansion, or property—not for general use. Some lenders monitor how you use the money.
- Tenure Flexibility: You can choose your repayment period within the lender’s guidelines.
What Are the Main Benefits of Getting a Term Loan?
Term loans offer several advantages that make them attractive to businesses.
- Predictable Monthly Payments: Fixed EMIs make budgeting easier. You know exactly how much to set aside each month, helping you manage cash flow better.
- Access to Larger Funds: Term loans provide bigger amounts compared to personal loans or overdraft facilities. This makes them suitable for substantial investments that can’t be covered by internal resources.
- Lower Interest Rates: Compared to short-term unsecured loans or credit cards, term loans often come with competitive interest rates.
- Build Your Credit Score: On-time EMI payments improve your credit history and credit score. A better credit score opens doors to more favorable loan terms in the future.
- Expand Without Draining Cash: You can invest in growth without pulling money from daily operations. This protects your working capital for regular business needs.
Who Can Apply for a Term Loan?
Term loans are available to both individuals and businesses. Let’s look at who qualifies.
For Businesses:
- Start-ups with a clear business plan
- Small and medium enterprises (SMEs)
- Established companies
- Self-employed professionals
- Proprietorships, partnerships, and companies
Basic Eligibility Criteria:
- Minimum age: Usually 21 years
- Maximum age: Typically up to 60-65 years for loan closure
- Business operational history: Most lenders prefer at least 2-3 years of operation
- Minimum annual turnover: Usually ₹25-50 lakh depending on the lender
- Credit score: A score of 650 and above increases approval chances
- Location: The business should be located in areas where the lender operates
Different lenders have different criteria. A start-up might struggle to get approval, but if you can show a strong business plan and personal guarantee, chances improve. An established business with consistent revenue and good credit history gets faster approvals for term loans.
What Documents Do You Need for a Term Loan Application?
Preparing documents in advance speeds up the application process. Here’s what lenders typically ask for.
KYC (Know Your Customer) Documents:
- Aadhaar card or PAN card
- Voter ID or passport
- Recent passport-size photographs
Business Documents:
- GST registration certificate
- Company incorporation certificate
- Trade license or business registration
- Partnership deed (if applicable)
Financial Documents:
- Balance sheet for the last 2-3 years
- Profit and loss statement
- Income tax returns (ITR) for 2-3 years
- Bank statements for the last 6-12 months
Collateral-Related Documents (if applicable):
- Property documents
- Equipment details
- Fixed deposit certificates
- Insurance policies
Some lenders now accept digital documents and have simplified the process. However, the requirement varies by lender and loan amount.
How to Apply for a Term Loan: Online and Offline Methods
Online Process:
- Visit the lender’s website
- Fill in your personal and business details
- Specify the loan amount and tenure you need
- Upload scanned documents
- Submit the application
- Track the status online
- Receive approval and disbursement
Offline Process:
- Visit the bank or NBFC branch near you
- Collect the loan application form
- Fill it out with all required details
- Attach physical copies of documents
- Submit the form at the branch
- Follow up on your application
- Complete the verification process
Most lenders now offer a hybrid approach—you can apply online and complete verification either digitally or at the branch. Digital applications are faster, often getting approved within 2-5 business days for existing customers.
Term Loan vs. Other Financing Options: How Do They Compare?
Different financing options serve different purposes. Here’s how term loans stack up against alternatives.
| Feature | Term Loan | Working Capital Loan | Overdraft/Line of Credit |
| Purpose | Long-term investment, equipment, expansion | Daily operational expenses | Flexible short-term use |
| Loan Amount | ₹5 lakh to several crores | ₹50k to ₹50 lakh (typically) | Based on your profile |
| Repayment Period | 1-15 years | 6-24 months | Ongoing/revolving |
| EMI Structure | Fixed EMIs each month | Flexible repayment terms | Interest on used amount only |
| Collateral | Often required for large amounts | Sometimes required | May require security |
| Interest Rate | Lower (fixed or floating) | Moderate | Variable, often higher |
| Best For | Capital investments | Short-term needs | Emergency funds |
What Are the Common Costs and Terms Associated with Term Loans?
Before you apply, understand the costs involved.
Processing Fee: Usually 1-3% of the loan amount. A ₹10 lakh loan might have a ₹10,000-30,000 processing fee. Some lenders charge this upfront; others deduct it from the disbursed amount.
Interest Rate: The cost of borrowing, expressed as a percentage per annum. Interest rates vary based on your credit score, business profile, loan tenure, and whether the rate is fixed or floating.
Prepayment Penalty: Some lenders charge extra if you repay the loan before the tenure ends. This lock-in period protects the lender’s interest income. After the lock-in period, prepayment is usually free or comes with minimal charges.
Late Payment Charges: If you miss an EMI payment, you’ll pay a penalty. Late payments also hurt your credit score.
Loan Cancellation Fees: If you cancel the approved loan before disbursement, some lenders charge a fee.
Documentation Charges: For physical document processing, some NBFCs charge ₹500-₹2000. Most banks now waive this.
Frequently Asked Questions About Term Loans
Term loans are typically for business purposes and require collateral for larger amounts. Personal loans are unsecured, have shorter tenures, and smaller amounts. Term loans carry lower interest rates for large amounts.
Yes, but it’s challenging. Most lenders want 2-3 years of operational history. Start-ups can get approval if they provide a strong business plan, personal guarantee, or collateral.
No. Small unsecured term loans exist, but they carry higher interest rates. Larger loans typically require collateral.
No. The loan is specific to the stated purpose (equipment, expansion, property, etc.). Using the money for different purposes can lead to loan recall.
Conclusion
Term loans are powerful financial tools for businesses and individuals planning substantial investments. They offer predictable repayment schedules, competitive interest rates, and the flexibility to choose tenure based on your cash flow capacity.
The key is understanding your business requirements, comparing lenders, and choosing terms that align with your financial capacity.
In short, with the right term loan, you’re not just borrowing money. You’re investing in your business’s growth and future success.
