Term loan – Definition and features

As the name says, term loan is a fixed period loan taken from bank for capital expenditure which is payable to bank at regular interval (monthly, quarterly, biannually or annually) through EMI.

There are basically two legs of Term Loan:

Intermediate term loan: under this type the tenure generally varies from one year to seven years.

Long term loan: The tenure for this loan varies from more than seven years and up to thirty years

Rate of Interest: Rate of interest charged under this arrangement with bank can be fixed or floating.

Under fixed rate of interest, the interest rate charged by bank on the loan will be fixed for the entire tenure of loan irrespective of the rate fluctuations in the market. This type of interest rate is beneficial when the receiver of the loan believes that the rate of interest will increase in the future. But if, the expectation for rate of interest is to fall in future, fixed interest rate could be expensive as a cost of finance.

Unlike fixed interest rate, bank also lends term loan on floating interest rate. Floating interest rate is basically calculated as Prime Lending Rate (PLR, the rate central bank charges to commercial banks) plus some spread/margin, example: say PLR is 12.25% + Spread 2.50%, in this case the total interest rate charged to the receiver is 14.75% p.a. This interest rate charged will be revised every quarter by the bank depending up on the then PLR prevailing in the market. Thus with the increase in PLR, interest rate charged will go up and vice versa.

Collateral: Under Term loan arrangement collateral needs to be provided. Collateral provided is in most of  the case are the equipment, property or any other item against which the loan is procured, but unlike in cases of pledging were the ownership of the property passes on the loan provider.

Upfront fee: Bank in most of the cases charges an upfront fee/processing fee which varies from 0.50% to 1.00% of the loan amount.

Penal Interest: The loan received may be given 3 months from the date of first disbursement for creation of mortgage on the property. Additional interest of 1.00% per annum will be charged form the date of first disbursement if the security is not created within three months time.