There are so many different types of business financing available today it can be daunting wading through all of them to figure out which one is right for you. In your search for business financing it is very likely that you have heard of a business term loan, but what exactly is it? A business term loan is not so much a type of business loan, as it is the definition for the length of time a business loan is fixed or amortized over. Although the technical nature of a business term loan has to do with its structure, it has come to be mostly associated with alternative online business lenders such as our recommended business term loan lenders OnDeck and SmartBiz.
What is a Loan Term?
Any business loan you get is going to have a term. This simply means the length of time you will have the loan for and usually applies to the amortization period or the period for which your interest rate is fixed. Amortization is the time period you will have to pay off your full loan amount borrowed including financed origination fees, closing costs and interest.
Usually business term loans are amortized over a shorter period of time when compared to real estate loans. Term loans tend to be less than 10 years in length and can even be as short as 3 months. Usually term loans will carry an interest rate that is fixed for the same length as the amortization of the loan. For example, if your loan is amortized for five years, your rate will usually be fixed for five years. There are short-term business loans that carry fixed rates for only a portion of the loan or adjust periodically, but these are usually not labeled term loans.
It’s Not a Merchant Cash Advance
The phraseology “business term loan” has gained popularity in the last decade as business lenders have tried to distance themselves from merchant cash advance (MCA) providers. Business term loans can often have similar attributes to an MCA, but an MCA is not a loan. An MCA is the pre-purchase of your future revenue at a discount, to be paid back out of your business cash-flow by a daily or weekly payment. For example, an MCA provider may purchase $10,020 of your future revenue for $6,000. The provider will advance you $6,000 now, and then withdraw a fixed payment from your business bank account until the $10,020 of revenue it pre-bought is received. This financing structure has historically been known as factoring and prior to the advent of the MCA, usually involved the pre-purchase of inventory or accounts receivables at a discount, not actual revenue. The term “factor rate” is used by MCA providers to explain the amount they are pre-purchasing from you and what you will have to pay-back. In the scenario above, the $6,000 the MCA provider advanced you will be paid back at about a 1.67 factor rate (1.67 x $6,000 = $10,020).
A business term loan is not an advance and includes principal and interest. It is not a pre-purchase of your future revenue and it carries a set loan amortization schedule with a fixed interest rate for the term of the loan. The confusion may lie in the similarity between many business term loans and MCAs. Many business term lenders will include a factor rate in the presentation of their loan terms. The rationale for this varies, but one reason is because of the popularity of MCAs during the Great Recession, many business owners became familiar with MCAs and factor rates. Another reason is that the factor rate scenario is very easy to understand; you receive X dollars and you pay back Y dollars. Compared to a traditional loan that has an interest rate and an annual percentage rate that reflects the total cost of a loan, the concept of a factor rate loan is easy to grasp.
Business term loans, even when they appear similar to MCAs are often significantly cheaper. If you were to convert the 1.67 factor rate outlined in the MCA example above into an annual interest rate over a 6 month period, it would equal about 134%. It is not uncommon for MCA factor rates when converted to annual interest rates, to well exceed 100%. In contrast, our recommended business term loan lender OnDeck offers interest rates starting as low as 9%, and SmartBiz offers rates starting at 6.25%.
The Benefits of a Business Term Loan
A business term loan carries many benefits similar to MCA financing but is much more affordable, can have a much longer repayment period and requires less paperwork than a bank or SBA loan.
- Funds can be available in as fast as one day
- Accessing financing can be done online with no or limited paperwork
- Interest rates are usually fixed for the full term of the loan
- Low credit scores and other issues may not be a barrier to financing
- Term loans are available from $1,000 to $500,000 or more
- Rates and fees are low compared to MCAs and can be comparable to SBA financing in some cases
- Term loans can help you build your personal and business credit
Business term loans are available to most business owners, they do not usually require tax returns or business financials and can be used for a variety of business purposes. Business term loan lenders are more forgiving when it comes to lower borrower credit scores and are more willing to lend to a business with a shorter operational history. Business term loan lenders often give incentives to repeat borrowers such as reduced interest rates and loan fees.
Business term loans can be an affordable and flexible avenue to quickly access capital for your business. Borrowers with the best credit scores and strongest businesses will be able to borrow at a cost comparable to an SBA loan but receive funds in about one day. Business owners with less than perfect credit can also utilize a business term loan at a significant cost savings to an MCA, but access funds just as quickly. Knowing that your business loan has a fixed rate and a predictable repayment schedule can also give you peace of mind, and enable you to hedge against rising interest rates, or capitalize on short-fuse business opportunities.