What Is a Term Loan? Types and How They Work

By Markets & Investing DeskUpdated Nov 10, 2026

Definition

A term loan gives a borrower a fixed sum up front that is repaid with interest on a set schedule ending on a specific maturity date, often to fund equipment, real estate or working capital.

Key takeaways

Most term loans amortize, so each payment covers interest and principal until the balance reaches zero.
A $100,000 loan at a fixed 8% over five years costs about $2,028 a month and roughly $21,660 in interest.
Lenders often match the loan term to the asset's useful life, such as five years for a van or 20 or more for a building.
SBA 7(a) loans run up to 25 years for real estate and 10 years for working capital, generally without balloon payments.

A term loan is a credit agreement in which a borrower receives a fixed sum up front and repays it, with interest, on a set schedule ending on a specific maturity date. The “term” is the length of that repayment period. Lenders offer term loans mainly to businesses buying equipment, real estate or other fixed assets, or funding working capital, though auto loans and personal installment loans follow the same structure.

How a Term Loan Works

A business applies by submitting financial statements, tax returns and other evidence of its ability to repay. The lender reviews cash flow, existing debt, the loan’s purpose and the value of any assets offered as security. If approved, the borrower signs a loan agreement that sets out:

Principal: the amount advanced, sometimes reduced by a required down payment on the asset being financed.
Interest rate: fixed for the whole term, or variable and reset periodically from a benchmark plus a margin. U.S. variable business loans have commonly been priced off the prime rate, and the Secured Overnight Financing Rate (SOFR) has replaced LIBOR in most new U.S. dollar loans.
Repayment schedule: the frequency and size of payments, and whether they cover principal and interest from the start.
Maturity date: the date by which the full balance must be repaid.
Collateral and covenants: the assets pledged and any conditions the borrower must meet, such as minimum profit levels or limits on new debt and dividends.

When a loan finances a specific asset, lenders often match the term to its useful life. A delivery van might be financed over five years and a building over 20 or more, so the asset is still producing income while it is being paid for.

Technically, the principal is due at maturity, but most term loans are amortizing: each payment includes interest and principal, so the balance falls steadily to zero.

Calculating a Term Loan Payment

For a fully amortizing loan with a fixed rate and equal payments, the periodic payment is:

Payment = P × r ÷ (1 − (1 + r)^−n)

where P is the principal, r is the interest rate per period (the annual rate divided by the number of payments per year) and n is the total number of payments.

Hypothetical example. A business borrows $100,000 at a fixed 8% annual rate for five years, with monthly payments. Assumptions: no fees, no down payment, interest compounded monthly.

r = 0.08 ÷ 12 = 0.006667
n = 5 × 12 = 60
Payment ≈ $2,028 per month

Over 60 payments the business pays about $121,660, of which roughly $21,660 is interest. In the first month, interest is $100,000 × 0.006667 ≈ $667, so about $1,361 of the payment reduces principal. Each later month, the interest portion shrinks because it is charged on a smaller balance, and more of the same $2,028 goes to principal.

The quoted rate is not the full cost. Origination or guarantee fees raise the effective cost, so comparing offers on annual percentage rate (APR) gives a better picture than the headline rate. With a variable rate, the formula gives only the current payment; the lender recalculates when the rate resets.

Types of Term Loans

By length

Short-term loans generally run less than a year, though the label is sometimes applied to loans of up to about 18 months. They are often used by firms that do not qualify for a revolving line of credit, or to bridge a temporary cash gap such as a seasonal inventory purchase.
Intermediate-term loans usually run from about one to three years and are repaid in monthly installments from operating cash flow.
Long-term loans run from about three to 25 years. They are generally secured by company assets, repaid monthly or quarterly from profits or cash flow, and often come with covenants that restrict other debt, dividends or owners’ salaries, or that require a portion of profit to be set aside for repayment.

Balloon and interest-only structures

Short- and intermediate-term loans may be structured as balloon loans: regular payments stay low, and a much larger final installment repays the remaining principal. Some loans start with an interest-only period, giving a new or expanding business time to generate income before full principal and interest payments begin.

Term Loan A and Term Loan B

In large corporate and leveraged lending, term loans are often split into tranches. A Term Loan A is typically held by banks, has a shorter maturity and amortizes meaningfully over its life. A Term Loan B is typically sold to institutional investors, has a longer maturity, carries a higher interest margin and repays only a small share of principal before a large payment at maturity. These labels describe syndicated corporate debt, not the term loans a small business gets from its bank.

Example: The SBA 7(a) Loan

The U.S. Small Business Administration’s 7(a) program, in which the SBA guarantees part of a loan made by a participating lender, shows these features in practice. Maturities depend on the borrower’s ability to repay, the loan’s purpose and the asset’s useful life, generally up to 25 years for real estate and 10 years for working capital and most other uses.

Borrowers make monthly principal and interest payments, which stay the same on a fixed-rate loan and change with the rate on a variable-rate loan. Lenders may allow interest-only payments during a startup or expansion phase, but balloon payments are generally not permitted. The SBA charges a prepayment fee only on loans with a maturity of 15 years or longer. Business and personal assets secure the loan until their recovery value equals the loan amount or the borrower has pledged all reasonably available assets.

Why Businesses Use Term Loans

A term loan lets a company acquire a costly asset now and pay for it from the income that asset helps produce. Buying a $200,000 machine outright would drain cash reserves; financing it leaves cash for payroll, inventory and other operating needs. A fixed-rate term loan also has a known payment and end date, which simplifies budgeting, and secured term loans for established businesses can carry lower rates than unsecured short-term credit.

Limitations of a Term Loan

Qualification is demanding. Lenders generally look for an operating history, solid financial statements and collateral, which can put term loans out of reach for new businesses.
Collateral is at risk. If the borrower defaults, the lender can claim pledged assets, and personal guarantees can extend that risk to the owners.
Covenants restrict flexibility. Limits on new borrowing, dividends or salaries can constrain decisions for years.
Rate and payment risk. On a variable-rate loan, rising benchmark rates increase payments. A balloon structure creates a large final obligation that may need to be refinanced.
Prepayment terms vary. Some term loans can be repaid early without cost; others charge a prepayment penalty.

Line of credit. A line of credit sets a borrowing limit that the business draws on, repays and draws on again, paying interest only on the amount outstanding. A term loan delivers the full amount once and is repaid on a schedule. Lines of credit usually fund recurring working capital needs; term loans usually fund one-time purchases.

Cash credit. In some banking systems, notably India’s, a cash credit facility is a revolving working capital account secured by inventory and receivables, with a drawing limit tied to those current assets. A term loan, by contrast, is a fixed amount repaid in installments, usually against fixed assets.

Loan term. “Loan term” on its own means the repayment period of any loan, such as a 60-month auto loan or a 30-year mortgage. “Term loan” names the product. Loan terms, in the plural, refers to all the conditions in the agreement: rate, fees, schedule, collateral and covenants.

FAQs

What is issuing long-term debt?

Issuing long-term debt means a company raises money it will repay over more than one year, either through a long-term loan, a private agreement with one lender or a small group, or by selling bonds, securities that can go to many investors and often trade. Both appear on the balance sheet as long-term borrowings, with the portion due within 12 months shown as a current liability.

The Bottom Line

Business owners weighing a large purchase such as a machine or building are the main audience for term loans. A term loan lets the asset pay for itself over time while cash stays free for operations. Before signing, compare offers on APR rather than the headline rate, and review collateral, covenants, rate resets and prepayment terms, since these can tie up assets and limit decisions for years.