Term Loan

What Is a Term Loan?

A term loan is a loan in which a borrower receives a single lump sum at the start and agrees to repay it over a fixed period under a schedule set in the loan agreement. Once repaid, the funds generally cannot be borrowed again, which distinguishes a term loan from a revolving credit facility. Businesses commonly use term loans to buy equipment, fund expansion, refinance existing debt, or finance acquisitions. Individuals encounter similar installment structures in mortgage and auto loans.

How a Term Loan Works

Each term loan has a few core features that the borrower and lender agree on in advance:

• Principal: the amount borrowed.
• Interest rate: which may stay fixed for the life of the loan or float with a benchmark rate.
• Maturity: the date by which the full balance must be repaid.
• Repayment schedule: the regular payments, often monthly or quarterly, that cover interest and principal.

Many term loans are amortization|amortizing, meaning each payment gradually reduces the principal so the balance reaches zero by maturity. Others leave a balloon payment due at the end. A term loan may be backed by collateral such as equipment or real estate, or it may be unsecured. Lenders often include a loan covenant that requires the borrower to maintain certain financial measures during the loan's life.

Term Loans in Practice

In large corporate financing, "Term Loan A" and "Term Loan B" describe different tranches of a syndicated loan. Term Loan A generally amortizes on a regular schedule and is typically held by banks. Term Loan B, often part of a leveraged loan structure, usually has little scheduled amortization and is frequently held by institutional investors.

Term loans offer predictable payment schedules and a defined end date, which can make budgeting easier. However, they also carry drawbacks. Floating rates can raise borrowing costs when benchmark rates increase, and missing a payment or breaching a covenant can lead to default. The repayment obligation continues regardless of how the borrower's business or finances perform.

Why It Matters to Investors

Term loans appear in company financial statements and debt footnotes, detailing amounts owed, maturity dates, and covenant terms. These details help investors evaluate a company's debt obligations, refinancing needs, and overall credit risk.