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Term versus revolving business loans

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A basic commercial bank loan is known as a term loan. In reality, bank term loans are often short-term, but because they are renewed over and over, they then become longer term loans. Lenders prefer self-liquidating loans where the use of the loan money ensures an automatic repayment scheme. Most term business loans are in amounts of $25,000 or more. Most have fixed interest rates and a set maturity date.The payment schedules for these loans will vary. Term loans can be paid monthly, quarterly, or annually. Some of these loans may even have a balloon payment at the end of the term of the loan.

There are several types of term loans. The American Bankers Association recognizes two types of term loans. The first is known as the intermediate term loan which usually has a maturity of one to three years. This is often used to finance working capital needs. (Working capital refers to the daily operating funds that small business owners have to have to run their businesses). Intermediate term loans may also be used to finance assets such as machinery that have a life of around one to three years, such as computer equipment or other small machinery or equipment. Repayment of the intermediate term loan is then usually tied to the life of the equipment or the time for which you need the working capital.

Intermediate term loan agreements will often have restrictive covenants put in place by the bank. Restrictive covenants will restrict management operations during the life of the loan. These are also to ensure that management will repay the loan before paying bonuses, dividends, and other optional payments.

While long term loans do exist lenders seldom provide long-term financing to small businesses. When they do agree to do this it is usually for the purchase of real estate or a large business facility. The bank will then only lend 65% - 80% of the value of the asset the business is buying and the asset then serves as collateral for the loan.There are other factors that small businesses have to deal with in bank loan agreements such as interest rates, creditworthiness, affirmative and negative covenants, collateral, fees, and prepayment rights. This is what makes a term loan much different then revolving business loans.

Because of the impact of small businesses many local governments offer revolving loan funds, or RLFs, to foster business growth. These loans are designed to fund businesses that cannot get traditional bank loans, either because their owners are seen as credit risks or because the business has not yet established credit on its own. Because these loans are subsidized or administered by government agencies, many Revolving Loans offer lower interest rates than conventional loans. The interest rate for a particular applicant will vary widely according to the business's financial condition and its ability to maintain sufficient profits. As these loans are repaid the money is then put back into the fund and made available for additional loans. The major difference between this type of loan and term loans is that while commercial lenders (banks and brokers) are in the loan business to make money, government agencies that offer RLFs to generate jobs and support the community. Agencies may extend Revolving Loans to:

  • Locally owned start-ups or expansions that create jobs
  • Businesses that employ local workers
  • Firms that redevelop land and vacant facilities for commercial use
  • Companies that need to procure new equipment and technologies
  • High-tech firms
  • Businesses owned and operated by minorities, women, and members of other economically disadvantaged groups

The major eligibility requirement for an RLF is that you must not have delinquent debt to the federal government. RLF borrowers must also be located within the local area that is sanctioned by the RLF committee.In addition before the loan is granted borrowers must demonstrate that they have exhausted all other financing alternatives and that the project will create or retain local jobs.

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