What is a Short Term Personal Loan? What You Need to Know
- March 25, 2021
- 6 min read
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If you’re shopping for a loan, it’s important to know the key differences between each type. Although it’s not the most fun process, it would serve you well to do your homework and consider all options. We understand that not everyone is versed in lending, so we aim to make it as simple as possible.
Emergencies happen to all of us, no matter how much we plan or prepare. A sudden life change like an unplanned surgery or a sudden equipment malfunction at your business can put you in a tight spot. If you need funds fast and have the ability to pay them back quickly, a short-term loan may be a good fit.
Unlike a long-term personal loan that can have terms of up to seven years, a short-term loan is meant to be paid back promptly, typically between 6-18 months. Since the funds are paid back in a shorter time frame, short-term loans have higher monthly payments than long-term, but you usually end up paying less interest in the end.
Regardless of the term amount, personal loans are on the rise. More and more consumers are turning to personal loans to help cover home improvements and debt consolidation. According to a recent TransUnion study, personal loan balances grew 19.2% year-over-year in the first quarter of 2019, reaching a new high of $143 billion.
A short-term loan is a type of installment loan, which is when you borrow a fixed amount of money to be paid back with interest in monthly payments. Most short-term loans are labeled as unsecured because you don’t have to put up collateral to cover the loan. Unlike a secured loan that can use assets to cover the lender’s risk, an unsecured lender will pull your credit history to determine your creditworthiness.
An unsecured short-term personal loan is considered to be riskier to lenders because there is not much that can be done if a borrower defaults on the loan. With that risk comes a higher interest rate. Although a long-term loan usually has a lower interest rate than short-term loans, you will likely pay more in interest over the life of the loan, due to the length of terms.
Without collateral, a creditor will use your credit score and debt-to-income ratio to use as a deciding factor for approval. Lenders use a unique formula to determine their risk-based on those numbers, and you will likely need a score of 670 or higher for approval, as that is what the industry deems as “good credit.” (link to What Is Credit and Should I Freeze Mine?) Your debt-to-income ratio is calculated by adding all of your monthly debt payments and dividing them by your gross monthly income. Evidence has shown that borrowers with a higher debt-to-income ratio are more likely to default on their monthly payments.
You can apply for a short-term personal loan with your local bank, credit union, or a variety of consumer finance companies. We can help match you with top lenders that offer competitive rates for your financial needs. As overwhelming as it can be, thankfully, there are laws to safeguard consumers from discrimination in lending practices. The Equal Credit Opportunity Act (ECOA) was enacted in 1974, which made it illegal for lenders to use race, color, sex, religion, or other non-creditworthiness factors when determining a loan application, establishing terms of a loan, or any other aspect of a credit transaction.
Before you start shopping for loans, you can get an idea of what you can afford by using an online loan calculator. You can play around by inputting different loan amounts, interest rates, and terms to estimate where you’ll need to fall on those factors with what you need to accomplish.
When shopping for funds that are needed quickly, it can be confusing to decide which is the best option. In your search, you are likely to come across payday loans. Short-term loans and payday loans are two of the top solutions consumers will seek when unforeseen circumstances affect personal finances.
A payday loan is also considered a short-term loan, but it’s typically paid back in one lump sum instead of installments. Payday loans are usually reserved for smaller expenses to be used immediately and may require you to authorize an auto-debit from your checking account to pay back the loan. Because the loan is secured by your paycheck and/or access to your checking account, lenders often won’t need to pull your credit, which makes it a good option for someone with little to no credit.
Being that payday loans are meant to be paid back in a week or two, you will be limited on how much you can borrow. That’s actually a good thing because they can become risky for the consumer when you borrow too much. A lot of times, people will find themselves stuck in a repetitive cycle of borrowing when dealing with payday loans.
When you need cash fast, a short-term personal loan can be just what you need. Oftentimes, you can receive your funds in just a day or two. Short-term personal loans can range from $1,000 to upwards of $100,000, but the average new loan is somewhere around $7,000.
Most of the time, you will not need to tie up your assets as collateral for the loan. The lender will determine eligibility for the loan based on your credit history and proof of income. The higher your credit score, the lower the interest rate, and the more funds you can borrow, so long as your income can cover the loan.
Short-term lenders are somewhat more flexible. If your credit is less than perfect, you can still borrow money, but you may end up paying more in interest fees. As long as you can prove consistent income, they’re likely to work with you and determine a loan amount they feel comfortable with. Payday lenders are less likely to work around your financial needs.
There are pros and cons to everything, and a short-term personal loan may not be for everyone. If you’re looking for a small monthly payment and don’t mind stretching out the life of your loan, you may want to consider a long-term personal loan.
With a short-term personal loan, you’ll need to pay off the balance within 18 months or so. The shorter the terms, the higher the monthly payments will be, so you’ll need to factor that into your budget. Additionally, the interest rates are usually higher than with a long-term loan because the lender will see a return for a shorter amount of time.
It’s important that you only borrow what you need and an amount you’re confident can be paid back within the terms allotted. Sometimes people get themselves into trouble when they are approved for more than what’s needed, and may have a hard time paying those funds back. Short-term loans are relatively easy to obtain, but with that comes the risk of getting stuck into a cycle of debt.
In summary, a short-term personal loan is a great financial solution when you’re in a pinch. They’re known to deliver the funds you need fast. Short-term loans are usually paid back in two years or less so you don’t have to worry about being tied to a debt for a long period of time.
Most short-term loans are unsecured, meaning you don’t have to use your assets to secure the loan. Lenders will pull your credit report and look at your debt-to-income ratio to determine the approval amount. There is less risk to you as the consumer since you don’t have to leverage things like your car or home.
Due to little risk, and the relatively ease of access, short-term loans are on the rise. More and more people are seeing that it’s a viable solution to help you get ahead in times of need. When done correctly, they can help cover emergency costs with not much payout. If possible, a short-term personal loan is better than a payday loan because you have more time to pay it back. With less wiggle room in a payday loan, you’re more likely to get stuck in a cycle of borrowing.
That being said, it’s imperative that you only borrow what you need. Keep the risk to yourself as low as possible so you can confidently pay it back on time. Take advantage of online tools and resources to assess what you can afford before getting into any new lending situation.
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