Advantages & Disadvantages of Term Loans

A term loan is a short-term financing option used by companies to purchase various assets. Term loans allow small businesses to spread out the costs of needed assets, but they can be challenging to acquire and carry the risk that you'll lose the property if you don't repay the debt.

Term Loan Advantages

Acquiring working capital to obtain equipment and supplies for primary business operation is a common motive for term loans. The cash in the bank ensures you have the funds to buy items for the company as needed, which offers an you an indirect psychological advantage of peace of mind.

Other primary advantages of term loans include:

  • Manageable monthly payments - Short-term loans range from 1 to 5 years, but some long-term loans have repayment periods up to 20 years, according to Entrepreneur. Because of the loan payoff timelines, your monthly costs are more affordable, which enables you to fit the assets and equipment you need into your ongoing budget.

  • Limited total loan costs - The financing costs on a term loan are reasonable as well, because you put up property as collateral. The bank has less risk because it can seize the property if you don't pay. Thus, your interest rate and interest charges over the life of the loan are relatively modest.

Term Loan Disadvantages

Entrepreneur points out that the most compelling drawback or risk of a term loan is that you expose your property to repossession. The best way to mitigate this risk is to act conservatively with the amount that you borrow so you have no concerns about making payments.

Other primary disadvantages of term loans include:

  • Depreciation - Though not necessarily a reason not to borrow, the fact that depreciation occurs swiftly with some equipment presents a challenge. If you pay down the debt slowly over a long period of time, and the equipment depreciates more rapidly, you risk owing more than the equipment is worth when you sell it.

  • Complicated process - Obtaining a term loan is sometimes complicated as well, especially if you are a new business and don't have much in the way of financial statements to provide. Banks like to review your current debt leverage and net income trends to determine risk. In lieu of actual statements, detailed and well-researched projections sometimes are needed.