Term loans: What they are and how they work
A term loan gives businesses upfront capital with fixed repayments over time.
Rho Editorial Team
Securing the right financing can make or break a company’s growth plans. If you’ve ever tried to fund payroll during a slow sales cycle or cover the upfront costs of a major expansion, you know how important predictable capital can be.
Among the many financing options available to startups and small businesses, the term loan remains one of the most straightforward, providing a lump sum of funding with clear repayment terms over a set period of time.
While many lenders offer term loans, not every loan structure fits every business. Let’s walk through how term loans work, the different types available, and when they make sense for your business.
What is a term loan?
A term loan is a business loan where the borrower receives a lump sum of funding upfront and repays it over a set period of time. Repayment typically happens in fixed monthly payments, which cover both the principal and the interest payments outlined in the loan agreement.
What makes a term loan appealing is predictability. Business owners know exactly what their repayment schedule looks like, including the interest rate, loan amount, and length of the repayment period. This structure makes it easier to plan around cash flow and budget for ongoing business needs.
A term loan is different from a revolving option, like a business line of credit. Instead of drawing funds only as you need them, the full loan amount is provided at once. That lump sum can be used immediately for expenses like equipment purchases, real estate, or refinancing, but it also means repayment begins right away.
These repayment structures vary depending on the type of term loan you choose.
How does a term loan work?
A term loan follows a straightforward structure: the borrower receives the full loan amount upfront, then repays it over a defined repayment period. Repayment is made in regular installments, usually monthly, until the loan is fully paid off.
Each loan payment typically includes two parts:
Principal balance
Interest payments
Depending on the lender, interest may be charged at fixed interest rates, which stay the same for the entire repayment schedule, or at a variable interest rate, which can change over time.
The details of the loan are outlined in the loan agreement, which sets the repayment terms, repayment schedule, and any additional costs like an origination fee or prepayment penalty.
Together, these factors determine the loan’s total cost, often summarized as the annual percentage rate (APR). Some lenders also offer interest-only periods at the start of the loan, giving businesses lower payments early on before shifting to full principal and interest repayment.
Before funding, lenders go through an approval process to review the borrower’s creditworthiness, financial statements, and intended use of the loan. On-time payments are often reported to business credit bureaus, which means consistent repayment can help strengthen your company’s credit profile over time.
Once approved, the loan is disbursed as a lump sum, and the repayment schedule begins immediately.
Types of business term loans
Not all term loans are the same. The right option depends on your business needs, loan amount, and preferred repayment terms.
Most lenders break them into four categories:
1 - Short-term loans (3–24 months)
Short-term loans usually last between 3 and 24 months. They often come with higher interest rates but have a faster approval process. Startups and small businesses use short-term loans to cover working capital, bridge cash flow gaps, or manage seasonal expenses.
2 - Intermediate-term loans (1–5 years)
With terms between 1 and 5 years, intermediate-term loans strike a balance between cost and flexibility. They are commonly used for purchasing equipment, funding expansions, or refinancing existing debt.
3 - Long-term loans (5–25 years)
Stretching anywhere from 5 to 25 years, long-term loans allow businesses to borrow larger amounts with lower interest rates. These loans are often tied to significant investments such as buying real estate, expanding production, or building out new facilities.
4 - SBA-backed loans (up to 10 years)
Backed by the Small Business Administration, SBA loans provide longer repayment terms and generally lower interest rates than many conventional options. The tradeoff is a more detailed application process and stricter eligibility requirements, but they can be a valuable tool for qualifying small businesses.
Overall, these loans often require lower down payments and carry capped interest rates, making them especially attractive for small businesses seeking affordable long-term financing.
Some startups also compare long-term loans with venture debt, which can provide larger amounts of capital without giving up equity.
Common uses of term loans for business needs
Business owners often turn to term loans when they need predictable funding for specific goals. Because the loan amount is provided upfront and repaid in installments, a term loan is well-suited for one-time projects and large investments.
Many companies use this financing to purchase equipment and technology that improve operations or expand production capacity. Others rely on it to cover working capital needs such as payroll, inventory, or day-to-day expenses during slow revenue cycles.
Expansion is another common reason for borrowing. Whether opening a new location or launching a major growth initiative, a term loan can provide the upfront investment required to get started.
The same applies to real estate, where loans are often used to buy offices, warehouses, or production facilities.
Refinancing is also a frequent use case. Businesses may replace higher-interest-rate debt from credit cards or short-term loans with a longer-term option at a lower interest rate.
This shift can reduce monthly obligations and free up cash flow for more productive uses.
For startups and small businesses, a well-structured term loan provides stability at critical points, giving owners the resources to act on opportunities without sacrificing control of the company.
Before approving any of these uses, lenders will look closely at the financial strength of the business.
Key factors lenders evaluate before approving a term loan
Before approving a term loan, lenders want to be confident that the borrower can meet the repayment schedule. The approval process often centers on a few key factors:
Credit score and credit history show how reliably the business or its owners have repaid debt in the past. Strong creditworthiness makes it easier to qualify for larger loan amounts with lower interest rates.
Financial statements, including income statements, balance sheets, and cash flow projections, help lenders understand the company’s ability to manage ongoing loan payments.
Business cash flow is especially important. Lenders want to see consistent revenue that covers both operating expenses and future repayment terms.
Collateral may be required for secured loans. Assets like equipment, property, or receivables give lenders confidence that they can recover losses if the borrower defaults.
Eligibility requirements differ by lender and loan type. Some lenders focus on established businesses with strong business credit, while others may be open to newer startups with strong revenue growth.
Together, these factors determine whether a loan is approved, the repayment period offered, and whether the borrower receives fixed or variable interest rates.
With these requirements in mind, it helps to weigh the broader advantages and disadvantages of term loans.
Pros and cons of business term loans
Like any financing option, term loans come with tradeoffs. Here’s a quick summary of what business owners should weigh:
Pros | Cons |
Access to larger loan amounts for significant investments | Requires strong creditworthiness and detailed financial statements |
Typically, lower interest rates than credit cards or short-term financing | May involve an origination fee and other upfront costs |
Predictable monthly payments and clear repayment terms | Creates long repayment obligations that limit flexibility |
Builds business credit through consistent repayment | Fixed repayment schedules can strain cash flow during slow periods |
Balancing these pros and cons is part of deciding whether a term loan fits your business’s financing needs.
How to decide if a term loan is right for your business
Deciding whether to take on a term loan starts with understanding your company’s financial position and growth goals. The first question is whether your projected cash flow can reliably cover loan payments over the full repayment schedule.
From there, consider whether fixed interest rates would provide the stability you need, or if a variable interest rate might work better, starting lower but carrying the risk of fluctuation over time.
It also matters how you intend to use the funds. Some businesses need short-term support, such as covering working capital, while others are looking at longer-term investments like buying real estate or expanding operations.
The purpose of the loan plays a big role in determining the best structure. For some, the goal may be growth, while for others, it may be refinancing existing debt on better repayment terms.
For many startups and small businesses, the choice isn’t about whether to borrow at all, but which financing option best supports their goals. Some owners value the predictability of term loans, while others lean toward a line of credit for its flexibility.
Once you’ve determined that a term loan could be the right move, the next step is understanding how to apply.
How to apply for a term loan
Applying for a term loan can feel complex, but the process usually follows a clear set of steps that help both the borrower and the lender determine if the loan is a good fit.
The application process for a business term loan generally involves these steps:
Research lenders and compare repayment terms, interest rates, and eligibility requirements.
Check your credit score and credit history, since lenders rely on these to assess creditworthiness.
Prepare your financial documents, including recent financial statements, tax returns, and cash flow projections that show your ability to manage loan payments.
Determine collateral requirements if applying for a secured loan. Lenders may expect assets like equipment, property, or receivables to back the loan.
Review offers carefully. Pay close attention to the repayment schedule, annual percentage rate (APR), and any costs such as origination fees or prepayment penalties.
Watch for additional obligations, such as late fees or personal guarantees, which some lenders require from smaller businesses.
This saves time, narrows down the best options, and reduces the uncertainty of the approval process. For many business owners, having guidance at this stage is just as valuable as the financing itself.
Compare real loan offers in one place with Rho
A term loan can be a practical financing option for startups and small businesses that need predictable funding to cover working capital, purchase equipment, refinance debt, or invest in real estate.
By providing a lump sum with a clear repayment schedule, it gives business owners stability when planning for both short-term needs and long-term growth. The challenge is less about understanding what a term loan is and more about finding one that fits your business.
Terms, interest rates, and eligibility requirements vary widely between lenders, which is why comparing options is such a critical step.
This is also where Rho plays a role. Instead of navigating the process alone, founders can see real offers from multiple financing providers and better understand how each one fits their stage and goals.
For many businesses, that clarity is what makes the difference between securing the right loan and taking on unnecessary risk.
Fund what’s next, with someone in your corner. Get started with Rho.
Summary and more FAQs about term loans
What is a business term loan?
A business term loan is a financing option where the borrower receives a lump sum of money upfront and repays it in installments over a set repayment period. Payments typically include both principal and interest payments.
How does a term loan work?
A term loan works by providing upfront funding with a defined repayment schedule. Borrowers make regular payments, often monthly, that cover the principal and the agreed interest rate, which may be fixed or variable.
What are the types of term loans?
Business owners can choose between short-term loans, intermediate-term loans, long-term loans, and SBA-backed loans. Each type differs in repayment terms, loan amounts, and interest rates.
What can a term loan be used for?
Common uses include purchasing equipment, covering working capital, expanding into new locations, buying real estate, or refinancing higher-interest debt.
What factors affect eligibility for a term loan?
Lenders look at a company’s credit score, credit history, and overall creditworthiness, along with financial statements, cash flow stability, and available collateral.
What is the difference between a term loan and a line of credit?
A term loan provides a lump sum with fixed repayment terms over a set period, while a line of credit is a form of revolving credit that lets businesses borrow and repay as needed for more flexible access to cash.
