Term loan
A term loan is a monetary loan that is repaid in regular installments over a fixed period of time. Term loans typically last between one and ten years, though maturities of up to 30 years are possible. Such loans accrue interest, which may be charged at a fixed or floating rate. Floating interest rates are commonly tied to benchmark rates such as Euribor, SOFR, or similar reference rates, and are often based on the borrower's credit rating.
Term loans are normally business loans and are in contrast to a line of credit or short term demand loans. Their longer repayment periods can be attractive to new or expanding enterprises, as borrowers may expect revenues and profitability to increase over time. Businesses often use term loans to raise capital for expansion, including increasing production capacity, acquiring equipment, or financing operational growth. Term loans may be issued as bank-syndicated debt or through the institutional loan market. Institutional term loans that trade on secondary markets are commonly referred to as Term Loan B. These facilities typically have maturities of around seven years and limited financial covenants. In U.S. law–governed loan transactions, they are generally classified as senior debt and are usually not subordinated to other indebtedness.
Considerations
The cost of the loan is the interest rate, which may be fixed or floating. Fixed interest rates remain constant over the life of the loan, while floating rates vary in line with changes in underlying market benchmarks. Because some term loans extend for ten years or longer, interest rate exposure represents an important risk consideration for both borrowers and lenders.Most term loans will use compound interest. If it does, the amount of interest will be periodically added to the principal borrowed amount, meaning that the interest keeps getting bigger the longer the term lasts. Although the term is fixed, the borrower may be able to repay it early in full, but there may be penalties for early repayment of the loan.
Lenders may offer different repayment structures. Commonly, loans are amortized with equal payments over the loan term, though some arrangements allow payments to increase gradually over time. While such structures may benefit borrowers expecting higher future income, they generally increase total interest costs and lender risk. Even payment schedules are often used to reduce the likelihood of default.