man meeting with woman at a bank
Short-term loans can be a top choice for businesses that need a smaller amount of cash relatively quickly, but can easily create debt if the repayment schedule cannot be completed. — Getty Images/fizkes

Often, one of the most challenging parts of starting a business is securing enough money to get the ball rolling. Even when you’ve carefully planned your budget and reviewed your balance sheets, the most meticulously structured financial plans can still go awry.

When this occurs, many aspiring business owners turn to traditional loans for financial support. However, despite its popularity, this isn’t always the best choice. Instead, many consider researching and applying for a short-term loan.

[Read: How Bridge Loans Bridge the Gap Between Financing and Business Growth]

What are short-term loans?

According to the Corporate Financial Institute, a short-term loan is a type of loan that is obtained to support a temporary personal or business capital need. Short-term loans provide quick cash when your cash flow is lacking, have shorter repayment periods than traditional loans and are an extremely attractive option for small businesses that are not yet eligible to apply for a line of credit from a bank. While the credit limit for short-term loans is lower than a line of credit, short-term loans are viable solutions to alleviate sudden temporary financial trouble.

Short-term loans are named as such because they require quick repayment. The way short-term business loans are repaid differs from typical loans for small businesses. Rather than monthly payments, according to LendGenius, those who borrow short-term loans typically repay them on a daily or weekly basis.

One of the most important things to consider before applying for a short-term loan is the annual percentage rate (APR), which directly affects how much you’ll wind up paying back for the loan all told, as it is unlikely you’ll get a prime rate with a short-term loan. Other factors that are important to consider include the origination fees and other applicable charges, late payment penalties and refinancing options.

[Read: Secured Business Loans: What Are They, and Should You Get One?]

Because the loan amounts are limited for short-term loans, the lending requirements are usually more relaxed, making it easier to get approved.

Advantages and disadvantages of short-term loans

Deciding to borrow money for your small business is not a decision to be taken lightly. To help you get started, LendGenius outlined the following advantages and disadvantages of applying for a short-term loan:

  • Loan amount. Since the funds of a short-term loan are not meant to be used as a long-term investment, the loan amount typically ranges from $5,000 to $300,000. However, once you’ve entered the repayment phase and have a successful and proven track record, the chances of you qualifying for a larger, longer-term loan in the future increase greatly.
  • Eligibility requirements. Because the loan amounts are limited for short-term loans, the lending requirements are usually more relaxed, making it easier to get approved. The approval and funding timelines are faster as well.
  • Repayment period. Usually, short-term loans must be paid off between 6 to 18 months. If you’re applying for a loan to take care of an emergency, short-term loans allow you to repay the loan amount in about a year so you can move on to other things.
  • Price of short-term vs. long term loans. One of the greatest disadvantages of short-term loans is the total expense of the interest rate. Because the loan term is significantly shorter than other loans, lenders can charge higher working capital loan rates to compensate for the added risk. In addition, short-term loans have the potential to become debt traps if you’re unable to keep up with your loan repayment plan. In the event that you aren’t able to pay on time, you could be forced to continuously refinance the loan and ultimately extend the repayment period and accumulate additional interest and fees.

[Read: How Can I Improve My Chances of Getting a Small Business Loan?]

Sources of short-term loans for businesses

There are several avenues of acquiring short-term loan financing, including:

  • Merchant cash advances.
  • Lines of credit.
  • Payday loans.
  • Invoice financing.
  • Overdraft agreements.
  • Accounts receivable financing.
  • Customer advances.
  • Selling goods on installment.

Short-term loans are great options for businesses who are momentarily strapped for cash. If you think you might be in need of quick financial support, consider securing a short-term loan for your company.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

Published September 30, 2019