Published on March 10, 2014
A term loan is a specific amount that has a specified repayment schedule and floating interest rate. Term loan is also called as term finance. It represents a source of debt finance, which is generally repayable in more than one year but less than 10 years. They are used to finance acquisition of fixed assets & working capital margin.
Term loan is available from bank for acquisition of commercial property , purchase of fixed assets and business expansion , including loan against property to business. This loan is useful for professionals, proprietors, partnership firms and private limited companies. Rate of interest is fixed on term loan and that is decided by the bank with help of RBI.
These term loan are offered by all commercial, developed and nationalized bank and state level financial institutions. Interest on long-term loan is deductible for tax purpose. The interest & principal repayment are obligation of company & threaten the solvency of firm if not paid in time.
Term loans represent secured borrowing. Usually assets which are financed with the proceeds of the term loan provide the prime security. Other assets of company may serve as collateral security. Term loan are generally secured through first mortgage or by way of deposit of title dead of immovable properties or hypothecation of movable properties.
There are 2 methods of repayment of term loans. i. One way is to pay installments of principal amount & interest in such way that the interest payment is reduced over years, So the installments will not be equal. ii. another method is to pay equal installments including interest & principal in this method as the interest goes on declining the amount of principal repayment goes on increasing.
In order to protect their interest, financial institution generally impose restrictive condition the borrowers. Here, Restrictive covenants depends on the financial situation of borrower. i. Provide periodic information about its operations. ii. Undertaking any new project and /expansion or make any investment in consultation with and to satisfaction of financial institution. iii. Seek the consent of financial institutions for additional borrowings and declaration of dividend at higher rate.
i. Financial institutions give rupee term loans as well as foreign currency term loans. ii. The most significant form of assistance provided by financial institutions, rupee term loans are given directly to industrial concerns for setting up new projects as well as for expansion, modernization and renovation projects.
iii. These funds are provided for incurring expenditure on land, building, plant and machinery, technical know-how , miscellaneous fixed assets, preliminary expenses, preoperative expenses and margin money for working capital. iv. Financial institutions provided foreign currency term loans for meeting the foreign currency expenditure towards import of plant, machinery & equipment and payment of foreign technical know-how fees.
v. The periodic liability for interest and principal remains in the currency/currencies of the loan and is translated into rupees at the prevailing rate of exchange for making payments to the financial institutions.
i. The cost of term loans is lower than the cost of equity capital & preference capital. ii. Lenders do not have the right to vote so term loans do not result in dilution of control. iii. Interest payments are tax deductible for company.
iv. Term loans are generally used for specified period of time. v. the company can refund the debt when its financial position sound.
i. Term loans results in legal obligation of paying interest & principal if not paid, can force the company into liquidation. ii. Term loans contracts carry restrictive covenants which may reduce managerial freedom Further they entitle the lenders to put their nominee on the board of the borrowing company iii. A Term loans increase the financial risk of company this tends to raise the cost of equity capital.
i. Term loan earn a fixed rate of interest & have a definite maturity period. ii. Term loans represent secured lending. iii. Term loans carry several restrictive covenants to protect the interest of lender.
i. Term loans do not carry the right to vote. ii. Term loans are not represented by negotiable securities.
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