Term loans mistakes: nine errors from sizing the request to closing the file

Most of the damage done by a term loan is done after everyone has stopped paying attention. The pricing conversation gets all the scrutiny, then the money arrives, and the provisions that decide how a bad year goes are never read at all.

Nine errors, in roughly the order they occur, from sizing the request to closing the file out years later.

What to take away

1. Sizing the loan to the approval

An approval is a ceiling, not a recommendation. Taking all of it because it was offered is how a business ends up carrying an obligation against something it never bought.

Build the number from a real list of what the money is for, with a quote or estimate against each line. Add a contingency you can name a reason for.

If the list is smaller than the approval, borrow the list. If it is larger, have that conversation now, not six months in, when a second application will be read against a balance sheet that already carries the first loan.

2. Letting the first payment arrive before the money has done its work

Financing usually buys something that takes time to produce a return. A machine has to be installed and commissioned. A fit-out has to be finished before it trades. A hire has to be trained.

If repayment starts before the asset earns, the gap comes out of working capital, and that is exactly the pressure that sends people looking for a second, faster, more expensive product. Ask about the timing of the first payment, and whether any deferral is available. It may not be, but the answer belongs in the plan either way.

3. Using a term structure for a timing problem

A term loan is a fixed sum, disbursed once, repaid on a schedule. That shape fits a purchase. It fits a gap poorly, because a gap opens and closes repeatedly and a term loan can only be drawn once.

Businesses that borrow a lump sum to cover a recurring shortfall spend the money, resume the shortfall, and now have a payment on top of it. If the need is a cycle rather than a purchase, a line of credit is built for the shape you actually have.

4. Forecasting from profit rather than cash

Only the interest portion of a payment appears as a cost in your profit and loss. The principal portion is a movement of cash that never shows up there at all.

The practical result catches people out every year: a business can be profitable on paper and unable to make the payment. Build the repayment into a cash forecast, not a profit forecast, and reconcile it against the weeks when receipts are thinnest rather than against an annual average.

5. Treating covenants as boilerplate

You can make every payment on time and still be in default. Covenants set what you must deliver, what you must maintain, and what you must not do without consent. Missing a reporting deadline is an avoidable breach, and a breach is an event of default whether or not any money was late.

Extract the covenant list into a calendar before the file is put away. Track the ratios yourself, monthly, so you see a breach coming rather than hearing about it. What these provisions cover is set out in application and repayment.

6. Borrowing again from the institution that already holds your facility

Convenience is real, and so is the risk of concentrating everything in one place. Ask two specific questions before signing a second agreement with the same institution: does a default on one obligation trigger a default on the other, and does collateral pledged for one also secure the other?

Where the answer is yes to either, a contained problem stops being contained. That may still be an acceptable trade for better terms, but it should be a decision rather than a discovery.

7. Reading the prepayment clause when you want to prepay

By then it is a fact rather than a negotiating point. Establish before signing whether early repayment is permitted at all, what it costs, and whether the charge falls away after a period.

It interacts with the cost basis. Where cost accrues on the outstanding balance, early repayment saves money, and a penalty stops you capturing it.

Where the charge was fixed at the outset, there is no saving to capture, and an exit fee is simply more cost. The term loans calculator sets out both cases with the arithmetic.

8. Refinancing to fix a cash problem

Replacing a loan with a longer one lowers the payment and raises the total, and rolling arrears, fees and costs into the new balance means borrowing to pay for borrowing.

Sometimes that is the right move, when it buys time that will actually be used to fix something. It is the wrong move when nothing underneath has changed, because the same problem returns against a larger balance and a fresh schedule. Test it on total cost from today to the end, never on the payment.

9. Not closing the file out

Repayment is not the end of the paperwork. A lien filed against your assets usually needs an active termination, and a personal guarantee needs to be released rather than assumed to lapse.

Neither happens automatically. A stale filing on your record is a routine, avoidable obstacle to your next financing. Confirm in writing who files the termination, then verify it was filed.

Ask what releases the guarantee at the same time. Guarantees often outlive the loan they were signed for. The structural background is in term loans.

Where to check anything specific

Terms, fees and rates come from lenders and change constantly. For general financing background with nothing being sold, the SBA business guide and the FDIC's Money Smart for Small Business are reasonable neutral sources.

Common questions

Which of these costs the most?

Usually the covenant one, because it converts a business that is coping into a business in default without a payment ever being missed.

Should I always borrow less than I am offered?

Borrow what the list supports. That is sometimes the full approval and often less.

Is refinancing always a bad idea?

No. It is a bad idea when it is used to make a payment disappear rather than to solve what caused the payment to be unaffordable.

How do I know if my lien was terminated?

Ask the lender for confirmation and check the public filing record yourself. Do not assume the release happened because the balance reached zero.