Written byA term loan is a lump sum advanced up front and repaid in scheduled instalments of principal and interest over a set term.
Also known as: business term loan, instalment loan
Key points
- Unlike revolving credit, the amount is fixed, the term is defined and the balance falls with every repayment.
- Terms usually run beyond twelve months, and can reach twenty years or more, depending on the purpose of the borrowing.
- A secured term loan is backed by property, vehicles, machinery or inventory, while an unsecured loan rests on credit history.
- Rates are fixed or variable: fixed brings certainty and possible break costs, variable moves with the market.
- Compare the comparison rate, which folds in most fees, rather than the headline rate alone.
How a term loan works
The lender advances the full amount, then you repay it on a schedule, most often monthly, though fortnightly and weekly options exist. Repayments usually amortise, so each one covers the interest that has accrued and then chips away at the principal. The interest share of each repayment is highest at the start and falls as the balance drops.
Some business loans run interest only for a set period before switching to principal and interest. Features vary: redraw, an offset account, the ability to make extra repayments, and break costs if you exit a fixed rate early. On a secured loan the lender takes a charge over an asset, such as a mortgage over property or a chattel mortgage over equipment.
Types of term loan and what they fund
Personal term loans cover debt consolidation, renovations and major purchases. Business loans fund capital expenditure, site fit-outs and growth. Equipment and machinery loans buy specific gear, and a car loan or commercial vehicle finance covers a ute, van or truck.
Working capital term loans handle cashflow when you want a defined repayment schedule rather than a revolving limit. A bridging loan covers a timing gap between two transactions. Mortgage style term loans are long dated secured loans over property, amortised across decades for large amounts. For asset specific needs, weigh a term loan against a finance lease or hire purchase.
Costs, eligibility and documents
Beyond the rate, watch establishment or application fees, valuation fees on property or equipment, monthly admin or service fees, early repayment fees and break costs on fixed rates, and default fees if a payment is missed. A comparison rate rolls most of those into a single figure, though it cannot capture every feature of the loan.
A personal applicant needs photo identification, proof of income, recent bank statements and a clear picture of existing debts and living expenses. A business needs an ABN, financial statements, recent BAS, business and personal bank statements, quotes or invoices for any asset, director identification, and security documents where the loan is secured. A clean credit file and a lower loan to value ratio improve the terms on offer.
Example
A cafe owner borrows $30,000 over five years to fit out a second site. The full amount lands in the business account at settlement, and the same instalment comes out monthly for 60 months. In the early months the interest share of each payment is at its highest, and as the balance falls more of each payment goes to principal. Because the rate is fixed the owner can budget the exact repayment for the whole term, though paying the loan out early could trigger break costs.
Not to be confused with
- Line of credit
- a line of credit is a revolving limit you draw and redraw, not a single advance
- Hire purchase
- under a hire purchase the financier owns the asset until the final payment is made
Frequently asked questions
What is the difference between a term loan and a line of credit?
A term loan is a lump sum repaid on a fixed schedule until the balance reaches zero. A line of credit is a revolving facility with a limit you can draw, repay and redraw, where interest is charged only on the balance you have actually drawn.
How are term loan repayments calculated?
Most term loans amortise, so the instalment is worked out to cover the interest accruing and clear the principal by the end of the term. Interest is charged on the outstanding balance, so the interest share of each repayment is highest at the start and falls as the balance drops. A repayment calculator shows the pattern.
Can I make extra repayments or pay a term loan out early?
Many loans allow extra repayments, which cut the balance and the interest that follows it. Fixed rate loans often restrict extra repayments and can charge break costs if you exit early. The loan contract sets this out, so check it before committing to a fixed term.
Are term loans secured or unsecured?
They can be either. A secured term loan is backed by collateral such as property, a vehicle, machinery or inventory, and usually prices better because the lender's risk is lower. An unsecured loan has no specific collateral and rests on your credit history and capacity to repay.
What happens if I miss a term loan repayment?
The lender can charge late or default fees and report the default to credit bureaus, which affects future borrowing. On a secured loan, continued arrears can lead the lender to enforce the security. Contact the lender early to ask about hardship arrangements.
Related terms
Broader term: Loan
Business loan
A business loan is finance for business operations, capital expenditure or growth, repaid with interest, either over an agreed term or as a revolving limit you draw and repay.
Read definitionPersonal loan
A personal loan is a fixed term loan for personal expenses, repaid in regular instalments over an agreed period, usually principal and interest.
Read definitionUnsecured loan
An unsecured loan is credit you borrow without pledging collateral, so the lender relies on your income, credit history and capacity to repay.
Read definitionLine of credit
A line of credit is a revolving credit facility with an approved limit that you can draw, repay and redraw, paying interest only on the drawn balance.
Read definitionEquipment finance
Equipment finance is business finance used to buy or lease machinery, vehicles and other equipment, where the equipment itself secures the loan or is owned by the financier.
Read definitionChattel mortgage
A chattel mortgage is a business loan for a vehicle or equipment: you own the asset from settlement and the lender holds a security interest until it is repaid.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.