Long-Term Loans

In this article, Shruti Chand (ESSEC Business School, Master in Management, 2020-2022) elaborates on long-term loans.

This read will help you get started with understanding long-term loans and how it is used in today’s world.

Introduction

A term loan or long-term loan refers to a loan from a bank for a specific amount of
funds with a fixed interest rate or a floating interest rate payable over a specified
schedule. A company uses term loans to fund the purchase of fixed assets, for
instance, manufacturing equipment, property, etc.

The term loans are issued by banks for short-term as well as long-term periods of
time. Depending on the needs of the business, the banks usually have different
types of term loan offerings. These loans differ from each other in their repayment
schedule as well as the type of interest rates.

Main aspects behind facilitating a term loan

1. Collateral:
Nature of term loans are usually very risky for the lender, hence the banks
usually require collateral and a rigorous approval process to grant term loans
to businesses.

2. Repayment schedule:
The repayment schedule is fixed by the bank at the beginning of the term loan
grant process. This is based on various factors that the bank considers about
the risk profile behind the loan. Generally, term loans do not carry any
penalties if they are paid off ahead of schedule. If the company does not pay
the obligations in time based on a pre-decided repayment schedule, the
banks charge a penalty which can be hefty. These repayment schedules can
be monthly, quarterly, or yearly.

3. Interest rates: The term loan bears an interest rate charged by the bank which is pre-decided. This interest rate can be either fixed throughout the tenure of the
term loan period or be a floating rate that fluctuates throughout the period of
the term loan. Let’s understand the types of interest rates to get better
understanding:

● Fixed interest rate:
This is straightforward as it is fixed based on the nature of the loan and
the time period. If the loan is relatively risky, the interest rate fixed will be
higher than that for a loan with low levels of risk.

● Variable interest rates:
The interest rates that differ along the period of the term loan are
referred to as variable interest rate. They are usually attached to the
value of a benchmark rate such as LIBOR (London Interbank Offered
Rate).

This interest can be represented in the following way: LIBOR + 0.5%
Hence, as the value of LIBOR changes, the interest rate also increases
or decreases along with it.

Various types of term loans:

1. Short-term loans: These loans are usually taken by companies for a period of
less than 1 year.

2. Intermediate-term loans: These loans are usually for a period of more than 1
year but less than 3 years. The company usually pays for these loans monthly
through the cash flow it generates through its operations.

3. Long-term loans: Any term loan for a period of more than 3 years can be
defined as a long-term loan. These loans require collateral to be granted by
the bank. The repayment schedule can be monthly, quarterly based on the
agreed terms in the beginning.

Long-term loans are present on the non-current liabilities of the balance of every
firm. Long-term loans cannot be avoided by a company especially when it is starting
out as it is a primary source of funding

You can read more about other forms of liabilities on a firm’s balance sheet.

Relevance to the SimTrade certificate

This post deals with Long-Term loans, which are taken up by companies and indicate their financial health.

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About the author

Article written by Shruti Chand (ESSEC Business School, Master in Management, 2020-2022).