Term Loan

The term loan is another bank offered product. A term loan is a floating or fixed rate loan that can be used to finance fixed assets, such as equipment, over a given period of time, generally no longer than the useful life of the equipment.

Benefits of Term Loan

The advantage of a term loan is that it offers a way for you to properly match the payback period of the equipment with the overall term of the loan. Term loans for equipment will typically range from 2 years all the way out to 7 years depending on the type of equipment. However, most term loans offered by banks will fall between 3 and 5 years.

Another advantage of a term loan is that if a fixed rate is offered, then monthly payments will also be fixed over the term of the loan. This allows you, the business owner, to forecast your cash flow with greater certainty.

One last advantage is that term loans for equipment don’t typically have balloon payments at the end of the term and because of this, you will own the equipment after the last payment is made. This can be both good and bad, but let’s assume you want to keep using the equipment after the last payment is made. What a great feeling it is to know that you now own that piece of equipment. Leasing your equipment does not mean that you will automatically get to keep it after you make your last payment. Often times in leasing, the equipment will be returned to the leasing company.

Disadvantages of a Term Loan

One disadvantage of a term loan is that it does not offer much flexibility. Often times a business owner does not know what they want to do with the equipment at the end of the term. Technology is constantly changing and that piece of equipment that they purchased using a bank term loan 5 years ago may no longer “cut it” in their industry. If a term loan was used to finance it, and there is no balloon payment after 5 years, then the business owner will have already paid for the entire piece of equipment. There is no point in returning it. At this point they will need to either sell the equipment or keep it, despite its old age.

One other disadvantage of a term loan is that a down payment usually comes with this territory. Banks generally shy away from 100% financing of any type. The reason for this is simple, the more of a loan the bank gives you relative to the assets value, the bigger the risk. Affording a down payment for your equipment is not always feasible depending on how much you have in cash reserves.

One last thing to note is that a term loan for a piece of equipment will show up on your balance sheet as a liability. This will have an effect on your debt ratios. While that may make no difference to you because you are a privately held business, any time you go to a bank for additional financing, they will rate you according to how much debt is on your balance sheet. If you don’t over extend yourself, this is no big deal. But if the ratios are close to the benchmarks of what a bank deems as appropriate then this could be the difference between getting “approved” or “declined”.