In the most basic definition, term loans are loans where the money is repaid in regular payments (or installments) over a set amount of time (or term).
The amount borrowed, the interest rates, and the period of repayment are all variables. Different lenders will have different rates and repayment agreements, so you should always make sure to read the fine print and find out all the details.
But here are a few things to look for:
Long Terms Loans and Short Term Loans
Originally the phrase “term loans” applied mostly to small business loans, and the loans were all for long periods of time. Now terms loans is a commonly used description for almost any kind of independent or small dollar loan.
Payday loans, title loans, and installment loans are all referred to as short term loans. A long term loan implies several years of repayment, as with a car loan or a mortgage.
Fixed or Floating Interest
Terms loans, especially in terms of business loans, often come with “floating” interest. Where a fixed interest rates locks the APR in for the life of the loan, a loan with floating interest can change the APR on your loan from payment to payment.
Floating interest rates can be extremely dangerous, especially if you are borrow for a long period of time. Fixed interest rates are always the smart play, even if the percentage seems a bit higher than floating.
Simple or Compound Interest
If your loan has compound interest, it means the amount of interest is going to be added to the principle amount. This will lead to a point where there is interest being charged on the interest!
In other words, you do not want a loan with compound interest.
Simple interest will have you paying interest on the principle balance, which will decrease with every payment. They call it simple for a reason – it makes paying off a loan so much simpler.
Early Payment Penalties?
Not all term loans have prepayment penalties, but some of them do. Particularly if you are paying compound interest, your lender may want you to stick to the payment plan for as long as possible. The longer you are paying on the loan, the more interest you end up paying.
Some companies use early repayment penalties to make sure you don’t try and save yourself some interest money. These penalties charge you a fee for paying down your loan, or for paying it off early.