What is The Key Difference Between A Term Loan and Working Capital loan?

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Term loan

When it comes to start-up enterprises and small and medium-sized business ventures, finance is often an issue, and this is where solutions like working capital loans and term loans come in. Both types of solutions can provide the entrepreneur with the much needed financial backing but vary in several respects. 

Broadly, working capital loans can be account receivables, business credit lines, factoring, advances and so on, while term loans can be short-term, intermediate or long-term, depending on the specific circumstances of the borrower. Term loan interest rates and working capital requirements notwithstanding, it is imperative for the borrower to be aware of the basic differences between the two, which are as follows – 

Duration of both – If you require immediate financial liquidity, the working capital loan is your best bet since it is usually short-term with a repayment period of a few months. On the other hand, a term loan can be spread over a short, medium or long span of time, depending on the understanding between the lender and the borrower. Likewise, repayment of a term loan can also vary from one year to several years and can at times span over a decade. 

Purpose of the package – While both provide financial support to the borrower, working capital and term loan serve different objectives. On its part, working capital is best suited for financing the daily operations of the venture and adding to the cash flow on an everyday basis. However, if you are keen on expansion or intend to upgrade, then it is a term loan that you should go for. 

Paperwork involved – To approve a working capital loan, lenders do not insist on too many documents. All they do is check your creditworthiness through the CIBIL score and past financial history, and having found everything satisfactory; they approve the loan. Term loans entail a lot of paperwork, as lenders ask for all the documents and ascertain creditworthiness after conducting a thorough check. Therefore, not only do term loans require more paperwork, but they also take longer for approval. 

Monthly instalments – Since the monthly instalment to be paid is directly affected by the amount of the loan, those for working capital are much less than for term loans. Given the smaller amount of money for working capital requirement, the number of instalments is also relatively lesser than those under the term loan, wherein the amount is much more substantial. 

Collateral requirement – As far as working capital loans are concerned, lenders do not ask for collateral as a rule owing to the amount being small and repayment tenor being short. Term loans have a different set of rules, wherein because of the comparatively larger amount and longer repayment schedule, lenders ask for collateral.  

Interest rates levied – Initially, lenders levy a higher interest rate on the working capital loan and a lower rate on a term loan owing to the emergency criteria and the lack of collateral in the case of the former. However, in the event that the interest rate on the term loan continues to accumulate over the long repayment schedule, it might become more than that of the working capital loan. 

Other than the term loan interest rates, which is determined by the time elapsed between disbursal and repayment of the loan, all the other benchmarks are totally different for these two financial solutions. Overall, a term loan is a secured loan, and hence requires an asset or property to be used as a collateral. Being unsecured, a working capital loan does not require collateral and can be repaid over a short duration, but attracts a higher rate of interest. 

Therefore, to meet your current requirements, opt for a working capital loan and ward off a financial emergency, and for long-term plans, apply for a term loan and gradually use up the funds.

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