What is Term Loan? Know Meaning, Types, Eligibility & Process

A term Loan is a loan from a bank, an NBFC or a financial institution that needs to be repaid according to a pre-defined repayment schedule. The loan is offered for a fixed term at a fixed or floating rate of interest, specified clearly in the loan agreement. The loan need not be serviced in lump sum by the borrower, but in EMIs or according to the repayment schedule shared by the lender.

Loan Repayment Methods

The common types of repayment methods for Term Loans are:

1. Amortisation- The repayment obligation is divided evenly across the loan tenure, such that the borrower is required to pay equal instalments over the loan period.
2. Balloon repayment- Herein, the last payment is the biggest. Through the life of loan, the borrower is either liable to repay interest only and/or a part of principal amount, followed by fat payment at the end of the loan, as per mutually agreed loan repayment agreement.
3. Bullet repayment: This works differently. Herein, at the end of the loan term, repayment is made in one instalment.

Types of Term Loan

There are three types of Term loans:

1. Short-term
2. Medium-term/ Intermediate Term
3. Long-term

The classification is based on the tenure of the loan. The loans are classified based on the loan tenor. Two other important factors of a Loan are loan amount and rate of interest.

Short Term Loan

Short Term Loans are small loans availed for 12 to 18 months. Some lenders allow borrowers to extend the tenure of Short Term Loans. These are borrowed for immediate, small to medium sized funding needs. Gold Loans, Personal Loans, Unsecured Business Loans etc are part of these loans.

Medium Term Loan

Medium Term Loans are loans that are availed for 3 to 5 years for big to medium size financing needs. Businesses opt for medium size term loans for financing purchase of machinery, equipments, working capital needs etc.

Long Term Loans

Long term loans are availed for high cost asset purchases or funding a high ticket financing need. The rate of interest and loan terms can vary extensively as tenure will range from 8 to 30 years. Long term loans generally have lower EMIs and lower rate of interest. Home Loans and Secured Business Loans are borrowed for long tenures.

How Term Loan Works?

To understand the functioning of term loans you must understand its features. Some of the common factors of Term Loans are:

Loan Amount- A Term Loan is approved for a fixed loan amount. The approval varies as per borrower’s credit score, credit history, existing loans and credit policy of the lender. The eligibility for loan amount will also change basis value of collateral and eligibility of co-borrower. The purpose of loan and government policies can also impact the loan amount.

Tenor- The loan instalments run through the loan tenure. The duration of loan is communicated with loan agreement and EMI size will vary as per the tenor of the loan. The loan is classified as short, mid or long-term loan according to tenor.

Collateral- A Term Loan can be secured or unsecured. When you pledge collateral for loan, you become eligible for bigger loan amount. The loan is offered as a percentage of value of collateral. Home Loan, Loans Against Property, Car Loan, Gold Loan are examples of Secured Term Loans, while Personal Loan or Unsecured Business Loan are examples of Unsecured Term Loans. 

Interest rate- A Term Loan is offered on fixed or floating rate of interest. Considering your repayment capacity and financial situation, you can choose the type of interest regime for your loan. Generally, Home Loans are offered on floating rate basis while Auto Loans and Personal Loans are offered as fixed-interest loans. There is also a combo loan option (fixed loan turning into floating loan, after certain years & vice versa) for Home Loans with some lenders.

Repayment schedule- The EMI of a loan comprises both principal and interest component. The calculation of EMI is as per the terms shared in the repayment schedule. You can use EMI calculator to verify each calculation.

These are some of the important aspects of Term Loan. The lender and borrower needs to come on terms to process the loan application.

Eligibility for Term Loans

Primarily, eligibility for Term Loans depends on the following:

1. Borrowers & co-borrowers should have a credit score of 700 or above.
2. Value of collateral to assess LTV.
3. Credit policy of the lender.
4. NMI/EMI ratio which should ideally be below 50%,
5. Past regularities in repayment of loans and Credit Card bills.
6. Relationship with the lender. Existing customers often can enjoy add-on benefits on the loan offer.
7. Last but not least, the recent credit behaviour of the applicant.

Process to Apply for Term Loan

1. First of all, you should shortlist a suitable lender for your financing needs. Use a loan comparison website like MyMoneyMantra to compare different loan offers available in the market and make an informed decision by choosing the lowest rate of interest and flexible terms.
2. Now fill out the application form of a chosen lender.
3. By applying online, you can avail of in-principal approval instantly.
4. Extract the list of documents required for the loan.
5. Upload documents and scan passport-size pictures.
6. In the shortest possible time, the loan will be processed online.
7. The process is alike for both secured as well as unsecured loans, except for the need to submit documents to prove the ownership of collateral with secured loans.