Detailed Definition
A Term Loan is a type of loan where the borrower receives a lump sum of money upfront and agrees to repay the loan over a fixed term with regular interest payments. At the end of this period, depending on the type of term loan, either the principal balance along with the final interest payment is due, or the entire amount may be paid off through gradual amortization. Term loans are commonly utilized by businesses for capital expenditures and by individuals for real estate purchases.
Key Characteristics:
- Maturity Date: A pre-defined date by which the entire loan must be repaid.
- Amortization: Generally, term loans have limited or no amortization, making large sums due upon maturity.
- Interest Rate: Fixed or variable interest rates paid periodically (annually, semi-annually, etc.).
Examples
Example 1:
Terry purchased a tract of land for $15,000 and borrowed $10,000 through a term loan with a 5-year maturity. The interest rate on this loan is 8%, payable annually. Thus, Terry will make annual interest payments of $800, and will owe the full principal amount of $10,000 at the term’s end.
Example 2:
A small business acquires a $50,000 term loan to finance new equipment, agreeing to a 10-year repayment term with an annual fixed interest rate of 6%. The interest payments are made annually, and the principal repayment is structured for a single lump sum at maturity.
Frequently Asked Questions (FAQs)
What is a term loan used for?
Term loans are used to fund large capital expenditures, such as real estate purchases, equipment financing, or other significant investments.
How does a term loan differ from a line of credit?
A term loan provides a lump sum with a fixed repayment period, whereas a line of credit offers flexible borrowing, allowing the borrower to draw and repay repeatedly within agreed limits.
Can the interest rate on a term loan change over time?
It depends on the loan structure. Some term loans have fixed interest rates while others have variable rates that may adjust periodically based on market conditions.
What happens if I can’t repay the term loan by the maturity date?
Failure to repay the term loan by the maturity date can result in default, leading to potential legal actions by the lender, additional fees, or loss of the secured asset, if any.
Balloon Mortgage
A type of loan that does not fully amortize over its term, which leads to a large lump-sum payment due at maturity.
Bullet Loan
A loan in which only the interest is paid during its tenure, and the principal is repaid in a lump sum at maturity.
Principal Balance
The remaining amount of a loan that needs to be repaid, excluding interest.
Interest Rate
The percentage charged on the total loan amount by the lender, providing their return for lending the money.
Online Resources
- Investopedia: Term Loan
- Federal Reserve: Term Loan Information
- Small Business Administration Loans
References
- “Principles of Real Estate Practice” by Stephen Mettling and David Cusic
- “Real Estate Finance & Investments” by William Brueggeman and Jeffrey Fisher
- U.S. Small Business Administration (SBA) - https://www.sba.gov/
Suggested Books for Further Studies
- “Commercial Real Estate Analysis and Investments” by David M Geltner and Norman G Miller
- “Real Estate Principles: A Value Approach” by David C. Ling and Wayne R. Archer
- “Finance for Real Estate Development” by Charles Long
Real Estate Basics: Term Loan Fundamentals Quiz
### What defines a term loan?
- [ ] A loan without any interest payments.
- [x] A loan with a set maturity date.
- [ ] A loan with variable weekly repayment schedules.
- [ ] A loan exclusively used for personal expenses.
> **Explanation:** A term loan is defined by its set maturity date, where the borrower is required to repay either periodically or in a lump sum at the end of the term.
### When are principal repayments typically made during a term loan tenure?
- [ ] At the end of every month.
- [ ] Every quarterly.
- [x] At maturity.
- [ ] Every two weeks.
> **Explanation:** Principal repayments for term loans usually occur at the maturity of the loan, where the entire amount may be due in a lump sum.
### What is the main type of payment made periodically in a term loan?
- [ ] Utility payments.
- [x] Interest payments.
- [ ] Principal payments.
- [ ] Property taxes.
> **Explanation:** In a term loan, periodic payments mainly consist of interest payments, with the principal balance often due at the end of the term.
### What occurs if a term loan is not fully repaid by its maturity?
- [ ] The loan is forgiven.
- [ ] No consequences.
- [x] The borrower defaults.
- [ ] The interest rates decrease.
> **Explanation:** Failure to fully repay the term loan by its maturity results in borrower default, which can lead to legal action from the lender.
### What kind of expenditures are term loans commonly used for?
- [ ] Everyday purchases.
- [x] Large capital expenditures.
- [ ] Subscription services.
- [ ] Minor home repairs.
> **Explanation:** Term loans are usually used to fund large capital expenditures, such as purchasing real estate or financing equipment.
### How is the interest rate typically characterized in a term loan?
- [ ] It is always zero.
- [x] It can be fixed or variable.
- [ ] It decreases over time.
- [ ] It remains the same as personal loans.
> **Explanation:** The interest rate on a term loan can be either fixed or variable, depending on the loan structure agreed between borrower and lender.
### Can you reuse a term loan for multiple withdrawals?
- [ ] Yes, it's similar to a revolving credit.
- [x] No, it provides a single lump sum upfront.
- [ ] Only if approved by lender monthly.
- [ ] Uncertain, depends on the borrower’s history.
> **Explanation:** Term loans provide a single lump sum upfront to the borrower; they are not revolving credit lines allowing multiple withdrawals.
### What distinguishes a term loan from a bullet loan?
- [ ] Repayment must occur monthly.
- [ ] Both are identical loans.
- [x] Bullet loans only involve interest payments until maturity.
- [ ] Term loans have no interest component.
> **Explanation:** A bullet loan involves only interest payments during its tenure, with principal repayment due as a lump sum at maturity, contrasting with term loans which may require periodic interest payments and have principal due at maturity.
### Who typically uses term loans?
- [ ] Mainly students.
- [x] Businesses and individuals needing substantial capital.
- [ ] Freelancers and part-time workers.
- [ ] Home renters.
> **Explanation:** Term loans are predominantly used by businesses and individuals requiring substantial capital for major investments, such as purchasing real estate or financing major projects.
### Can term loans have amortization?
- [ ] No, it never includes amortization.
- [ ] Always comes with steep amortization.
- [x] They can, but typically have limited or no amortization.
- [ ] Only if it excludes interest.
> **Explanation:** Term loans can include amortization, but it is generally limited or not present at all, with significant sums due at loan maturity.
