What is Term Loan ?

A term loan has a set maturity date and usually has a fixed interest rate.

The Term Loan is the primary source of long-term debt raised by the companies to finance the acquisition of fixed assets and working capital margin. It is also called as a term finance which means the money raised through the term loans is generally repayable in regular payments i.e. fixed number of installments over a period of time.

How it works (Example):
Let’s say Company XYZ wants to borrow Rs. 1 Crore to build a factory. It meets with its bank, ABC Bank, to negotiate the loan. The company and the bank agree to a 10-year loan with quarterly payments and a 9% interest rate.

Term loans often mature within 10 years, but this is negotiable. They usually require collateral. Not all banks make term loans, and an existing relationship with a bank is usually helpful.

Why it Matters:
Term loans are very common, and they provide a level of certainty to the borrower and the lender. The borrower usually has access to the full amount of principal upfront, knows when to make payments, and knows how much to pay. The lender knows that the principal will be repaid over time on a regular basis.

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Advantages of Term Loan

  • Interest on debt is tax-deductible, whereas the equity or preference dividends are paid out of profit after tax.
  • There is no dilution of control of the management, since, in the debt financing, the lenders have no right to vote.
  • The lenders are not entitled to the profits of the firm as they are only paid the principal and the interest amount.
  • An issue cost of debt is less expensive as compared to the preference and equity capital.
  • The maturity of the debt instrument can be altered with respect to the funds requirements in the firm / company.
  • Generally, it is easier for the management of the firm / company to communicate the proprietary details to the private lenders than to a public capital market.

i. From Point of View of the Borrower:

Cheap:

It is a cheaper source of medium-term financing.

Tax Benefit:

Interest payable on term loan is a tax deductible expenditure and thus taxation benefit is available on interest.

Flexible:

Term loans are negotiable loans between the borrowers and lenders. So terms and condi­tions of such type of loans are not rigid and this provides some sort of flexibility.

Control:

Since term loans represent debt financing, the interest of the equity shareholders are not diluted.

ii. From Point of View of the Lender:

Secured:

Term loans are provided by banks and other financial institutions against security—so term loans are secured.

Regular Income:

It is obligatory on the part of the borrower to pay the interest and repayment of principal irrespective of its financial position—hence the lender has a regular and steady income.

Conversion:

Financial institutions may insist the borrower to convert the term loans into equity. Therefore, they can get the right to control the affairs of the company.

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Disadvantages of Term Loans:

Term loans have several disadvantages which are discussed below.

i. From Point of View of the Borrower:

Obligation:

Yearly interest payment and repayment of principal is obligatory on the part of bor­rower. Failure to meet these payments raises a question on the liquidity position of the borrower and its existence will be at stake.

Risk:

Like any other form of debt financing term loans also increases the financial risk of the com­pany. Debt financing is beneficial only if the internal rate of return of the concern is greater than its cost of capital; otherwise it adversely affects the benefit of shareholders.

Interference:

In addition to collateral security, restrictive covenants are also imposed by the lenders which lead to unnecessary interference in the functioning of the concern.

ii. From Point of View of the Lender:

Negotiability:

Terms and conditions of term loans are negotiable between borrower and lenders and thus it sometimes can affect the interest of lenders.

Control:

Like other sources of debt financing, the lenders of term loans do not have any right to control the affairs of the company.

Documents Required For Applying to Bank for Cash Credit

ID proof : Pan card/ Passport/c Driving License

Signature Proof : Pan card/ Passport/Driving License

Age Proof : Pan card/ Passport/Driving License/DOB Certificate

Residence Proof : Passport/ Voter Card/Driving License/Ration Card/ Telephone Bill.

Office Proof : Telephone Bill/ Sales Tax registration certificate/ Electricity Bill

Ownership Proof : Electricity Bill/house tax/property papers Income Proof : last 3 years audited financial along with audit report with all

Bank statement : main account last 6 month. Sanction letter of existing Cash credit or overdraft limit availed by the company.

Collateral Security : Property papers which are offered.

Constitution proof : MOA/ partnership deed

Others : any Govt. registration like service tax, sales Tax, excise,

Loan Proof : Repayment Schedule of all running loans.

 

Eligibility Criteria for Different Employment Types

  • Limited or Private Limited Company
    Net income of the concern should be more than Rs. 150,000 per annum for business loan up to Rs. 1.5 million and over Rs. 300,000 for business loan above Rs. 1.5 million.
  • Partnership or Proprietorship Firm
    A minimum of 25% stake each can be clubbed to the income of the concern
  • Chartered Accountant / Self Employed Professional
    Who possess diploma or degree in any of these discipline like art / craft /profession or Who possess the skill that is considered as a profession from banks perspective shall be considered for any financial assistance. For example: Dental Surgeons, Accountants, Medical Practitioners, Engineers, Craftsmen, Management consultants, Construction contractors etc.

Factors Deciding Business Loan Eligibility

To be eligible for a business loan there are a lot of factor that are considered. Every bank that offers loan will look into many criteria prior to sanctioning it. Few important ones are:

  • Age Limit: The applicant should be min 21 years & max. 65 years.
  • Income: Business should be profit making at least for the past 2 years.
  • Turnover: Rs. 150,000 p.a. should be the minimum annual income.
  • Co-applicants: This is optional to the applicant, not mandatory in case of business loan.

Factors that Negatively Impact Business Loan Eligibility

There are main factor that affect business loan eligibility directly and indirectly, some on the critical ones are explained below. This helps each individual to make sure they are legally eligible for a business loan. The negatively impacting factors are:

  • Credit Rating: Each individual applicant’s credit worthiness is evaluated by the bank before processing the application. Good credit rating will increase the chance of getting the loan with more flexibility. Default payments, fraudulent activities, and outstanding huge loan will impact negatively on the potential, if one bank rejects you application due to credit rating issue; there is less chance of other banks accepting it, unless you are ready to pay big amounts as interest.
  • Employer: If the employer with whom the applicant is working has a bad reputation in the market, without any second consideration, the application will be rejected. There are ample examples of this type seen often. The employer should be having a good credit rating, there are many rating agencies that rate these companies in today’s market and this information is readily available online for each and every one. Working for such employer should be reconsidered as it will not just affect you when applying loans by also to the career itself in the long run.
  • Criminal Background: If ever the applicant has had a criminal background or if there is a suspect case filed against the applicant, there is absolutely no probability of getting a loan. All banks will be willing to offer loan only to those who are capable of paying the principal amount along with interests and those who are good in the eyes of law.
  • Business Instability: It’s a crucial aspect for business loan consideration. If the income of the business is not stable and the profit is marginal then banks will be in need of collateral for approving the loan. Weak profit will affect the business negatively, thus it is essential to apply for a business loan only if the business is able to meet all eligibility criteria.

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