A short-term business loan is a loan that works much like any other business loan. A lender gives your company money that it can use for some purpose or another. Over time, you pay back the money that you borrowed, plus interest. Short-term business loan interest rates may also be higher than rates for other loans.
Key Points:
- Don’t borrow unnecessarily: debt means paying interest which is a cost you can avoid.
- Debt can be a tool: though you shouldn’t borrow when you don’t need to, being scared of debt can slow business growth.
- Budget carefully: always have a backup plan for repaying your debts
Short-Term Business Loan Details
The main difference between short term vs long term loan is in how long you have to pay the loan back. With short-term business loans, repayment is expected to happen soon, sometimes as soon as weeks or months though rarely longer than a year.
There are few main types of short-term business loans.
- Business terms loans: These are relatively standard loans. You get a lump sum and repay the loan in regular payments.
- Business lines of credit: A business line of credit lets you draw funds only when you need to and pay interest only on your outstanding balance.
- Invoice factoring: Invoice factoring technically isn’t a loan but works similarly. With invoice factoring, you sell your unpaid invoices to a buyer, who sends you an advance, minus a fee. When the buyer of the invoice receives payment from your customer, they send additional funds so you get the full amount you were owed, minus a fee. You pay a small amount to avoid having to wait for customers to pay their invoices.
For example, if you send an invoice for $10,000 to a customer, your invoice factoring company might advance you $8,500. When your customer pays the invoice, the factoring company may send you $1,200 more, keeping $300 as its fee.
How Do Short-term Business Loans Work?
Short-term business loans work much like any other business loan. The most important difference is that you have to repay them quickly. It’s not unusual to see repayment periods as short as three months. Rarely, they can extend up to one year.
Because they have short repayment terms, the monthly payment for short-term loans is usually higher than for long-term loans.
Some short-term lenders also demand more frequent repayment than the typical monthly schedule set by, for example, long term loans. You might be expected to make payments every week or twice per month.
When to Consider Short-term Business Loans
Short-term business loans can be a useful tool for business owners. You might consider one in a few situations.
- Interruptions to cash flow: Imagine a scenario where a major customer informs you that they’ll be two weeks late on paying your latest invoice. If you rely on that income to make ends meet, you have to come up with cash to cover your costs during those two weeks. A short-term loan can help you get through the interrupted cash flow.
- Short-term business opportunities: Sometimes, you need extra funds to take advantage of an opportunity that won’t last long. For example, if a prime location in the heart of town becomes available, a short-term loan might be needed to help you secure a lease so you can help grow your company.
- Emergency expenses: Just like people, businesses can have financial emergencies. If an essential piece of equipment breaks for example, a short-term loan can help you cover the cost.
Why to Avoid Short-term Business Loans
Short-term business loans aren’t a cure-all, they have many drawbacks to consider.
- Inability to make payments: Short-term loans have much higher payments than long-term loans require. If your business can’t handle those high loan payments, avoid the loan.
- High annual percentage rates: Some short-term business loans are akin to payday loans, charging higher interest rates.
- Frequent repayments: Some lenders will expect you to make more frequent payments. You might even be expected to make weekly payments, which can be hard for a business experiencing financial hardship.
- Partially amortized repayments: Some short-term business loans don’t fully amortize through their regularly-scheduled payments. That means that you’ll be expected to make a larger balloon payment at the end of the loan.
- Risk of repeated refinancing: Because of their high costs, many businesses struggle to repay their short-term loans. You might find yourself rolling an existing loan into a new one and falling into a cycle of debt.
If short-term business loans are not for you, you might wish to look into more term loan types.
How to Get a Short-term Business Loan
If you’re considering a short-term business loan, follow these steps.
- Evaluate your borrowing needs: Before applying for a loan, you need to fully understand your financial situation. Determine how much you need to borrow and consider different repayment schedules. This will help guide your search for a lender.
- Check your credit score: Take the time to check both your individual and business credit scores. Some companies offer short-term business loans for bad credit while others focus on people with excellent credit. Your credit score also impacts the interest rates and fees you’ll pay, so you can use this information to predict loan costs.
- Compare lenders: Don’t just find one lender and go with them. There are hundreds of lenders out there, each offering different small business loan terms. Compare multiple companies to find the one offering the cheapest loans.
- Submit a formal application: Once you’ve settled on a lender, submit the formal application. This will involve providing some personal and business information and allowing them to examine your company’s finances.
Frequently Asked Questions (FAQs)
Before you apply for a short-term business loan, make sure you understand how they work.
