When Short-Term Loans Make More Sense Than Long-Term Loans for Your Business

Repayment terms can impact interest rates, credit score requirements and more.

Once you have made your mind that you need a loan for your business, that’s when the real work starts. If you are taking out a  business loan for the first time, then the process can feel intimidating at first. But most businesses eventually come to this point and there are plenty of resources available to walk you through every step of the process.

First off, it’s important to learn more about small business loans in general. Loans have unique vocabulary and simply recognizing a word isn’t enough — you need to truly understand its meaning to know what exactly it is you’re signing up for. Additionally, you’ll need to be prepared to answer questions about your actual and future financial health, as well as your tolerance for risk before choosing between a short-and long-term business loan.

One important distinction is short-term versus long-term loans as it impact many facets of the loan you receive. Keep reading to get an understanding of each type of loan, how they vary from one another and how to decide if and when a short-term loan is the right choice for your business.

What Is a Short-Term Loan?

A short-term loan is exactly what it sounds like — it’s a loan with a shorter term, meaning a quicker repayment period. Short-term loans are flexible and can vary. But generally, term period for short-term financing is less than one year. Such financing provides you with quick ways to get liquidity. It can help you fulfill small economic needs in the immediate future and also allows your business to capitalize on opportunities. However, short-term financing typically comes with higher interest rates and, in general, doesn’t fulfill long-term capital investment needs, therefore it may be ideal in some situations but not all.

Many kinds of short-term loans can only be used for specific purposes, such as purchasing vehicles or buying properties, which can be limiting if you need it for something else. However, these restrictions are not applicable to all short-term loans and you may be able to find a loan that suits your business needs. The most common uses include a need for more working capital, taking advantage of unforeseen business opportunities or in emergencies, to pay for losses. Term lengths are small and generally easily attainable depending your personal and/or business credit scores.

Read: The Best Ways to Use Financing to Grow Your Business

What Is a Long-Term Loan?

A long term-loan is a loan with a longer term, often several years or even decades. Mortgages, for example, can commonly have terms as long as 15 or 30 years, making it a form of long-term financing.

Although short-term loans may at first have higher interest rates, in general, business owners who take on long-term loans end up paying more in interest. Even if the interest rate is lower, the longer term means you incur interest on the money you borrowed, which may compound over time.

Qualifying for a long-term loan can be challenging as the lender is taking on considerable risk. Your lender will want to make sure that they lend money to someone who is able to repay it and they’ll likely examine your credit history and review your assets as part of the loan application process. Long-term business loans are best for people who want to make huge investments and need significant access to capital over a long period of time.

Why Are Short-Term Loans a Good Option for Your Business?

Short-term loans are easier to qualify for and quicker to receive than conventional business loans, making them ideal if you’re in a tight spot and need funds quickly. Typically, short-term loans require less documentation than long-term loans so the process can be faster and less stressful in some situations. Also, bad credit is not necessarily an obstacle to getting a short-term loan approved. Short-term loans have higher interest rates and typically come in lower amounts than long-term loans, making them less of a risk for the lender. The primary reason you might consider a short-term loan over a long-term loan is if you’re a business owner with little or no credit history.

Short-term loans are suitable to help with unexpected business problems. They are not only suitable in a time of crisis, but they can also be used for an unforeseen event or opportunity. Short-term loans can cover project costs that will be recovered in a couple of months. Plus, there’s no limit to how you can use the funds.

Short-term loans are a good option for those who have been in business for only a short period of time, are facing credit problems or are not eligible for traditional term loans. Just be sure to get a full understanding of the interest rates and repayment term, as interest costs may be high and missing a payment will hurt your credit score.

See: 7 Reasons to Start an Online Business

When Does a Short-Term Loan Make Sense For Your Business?

Choosing a short-term loan over a long-term loan doesn’t make sense in just any situation. There are some key considerations you should evaluate to determine if your current situation is posied for a short-term business loan. To help, check out these common scenarios in which a short-term loan might be a better match for your small business. If any of these situations sound familiar, it might time to start researching short-term business loan options.

1. To Cover Short-Term Operational Costs

If you need seasonal support or a particular piece of equipment to meet an unusually large project, then short-term loans are an optimal choice for you.

Related: Seasonal Business Ideas for Summer

2. Emergency Situations

Occasionally, unforeseen problems occur. It is necessary to have the cash to deal with these situations as soon as possible and to get back on track. Whether it’s a crashing network system or malfunctioning packaging machinery, when an emergency arises, you can get a short-term loan to repair it.

3. Cash Flow Gaps

Every company is unique and has different types of situations, which can create differences in cash flow. When you don’t have the cash now but can count on the money that comes in within a specified period of time, short-term loans will help you get over the hurdle so you can continue to operate your business smoothly.

The Bottom Line

Business owners with cash requirements face significant decisions about how to manage them. Instead of withdrawing money from other expenses like payroll, a short-term loan can cover expenditures without disrupting day-to-day payable accounts. In other words, if you know you’ll quickly recover from the financial event, the best solution could be a short-term loan.

Whether it fills a gap in cash flow or inventory management or buys machinery that quickly enhances sales, a short-term loan will help ensure that you have the resources at your fingertips to tackle whatever comes along.

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