A basic commercial bank loan is called a bank term loan or a commercial loan. A bank term loan has a particular term or length of maturity and usually a fixed interest rate.
The repayment of the principal of bank term loans is usually amortized, which means that the principal and interest are set up as equal periodic payments designed to pay off the loan in a specified period of time.
In the past, small businesses have lived and died on the strength of bank loans, their primary source of small business financing. During the Great Recession of 2008, this somewhat changed as banks became more reticent to lend and small businesses had to start looking at alternative sources of financing.
Types of Bank Term Loans
The American Bankers Association generally recognizes two types of bank term loans. The first is the intermediate-term loan which usually has a maturity of one to three years. It is often used to finance working capital needs. Working capital refers to the daily operating funds that small business owners need to run their businesses.
Working capital loans, however, can be short-term bank loans and often are. Companies often want to match the maturities of their loans to the life of their assets and prefer short-term bank loans. In reality, bank term loans are actually short-term, but because they are renewed over and over, they become intermediate or longer-term loans.
Intermediate Bank Loans
Intermediate bank term loans can also be used to finance assets such as machinery that have a life of around one to three years, like computer equipment or other small machinery or equipment. Repayment of the intermediate-term loan is usually tied to the life of the equipment or the time for which you need the working capital.
Intermediate-term loan agreements often have restrictive covenants put in place by the bank. Restrictive covenants restrict management operations during the life of the loan. They ensure that management will repay the loan before paying bonuses, dividends, and other optional payments.
Long-term Bank Term Loans
Banks seldom provide long-term financing to small businesses. When they do, it is usually for the purchase of real estate, a large business facility, or major equipment. The bank will only lend 65% - 80% of the value of the asset the business is buying and the asset serves as collateral for the loan.
Other factors that small businesses have to deal with in bank term loan agreements are interest rates, creditworthiness, affirmative and negative covenants, collateral, fees, and prepayment rights. Creditworthiness has become particularly important since the Great Recession of 2008.
Bankers prefer self-liquidating loans where the use of the loan money ensures an automatic repayment scheme. Most term loans are in amounts of $25,000 or more. Many have fixed interest rates and a set maturity date. Payment schedules vary. Term loans may be paid monthly, quarterly, or annually. Some may have a balloon payment at the end of the term of the loan. A balloon loan is when the sum of principal and interest is not fully amortized over its term, often to keep the periodic payments as low as possible. Thus, the remaining sum, usually principal, is due at the end of the term.