What does a bakery gearing up for the festive season, a bustling coffee shop with a broken espresso machine, and an event planning company that just landed a larger-than-usual gig have in common? They are all examples of small businesses that need a short-term loan.
Short-term loans could help them with extra inventory, machine repairs, and additional temporary staff wages. And if your small business has any cash flow gaps or unexpected opportunities, a short-term business loan could solve your problems, too.
Welcome to Short-term Loans 101, where you learn everything you need to know for your business.
What Is a Short-Term Business Loan?
What is a short-term business loan, and how do short-term loans for businesses differ from personal loans?
A short-term loan is a type of loan that, in most cases, must be paid off within six months to a year. Hence the name, as it has a short term. A loan term is the amount of time the borrower has to repay the loan amount.
Short-term loans from online lenders usually have a much shorter duration than traditional business loans and personal loans. Short-term business loan repayments typically come out of the borrower’s business income.
How Does a Short-Term Business Loan Work?
Short-term business loans operate similarly to longer-term and traditional loans, but there are a few key differences.
Application
You apply to borrow a sum of money for your business, by filling in some basic details and choosing the amount you need to borrow. Many short-term loan applications are conducted online and take mere minutes. This makes applying for a loan quick, easy, and convenient.
Documentation
Depending on the lender and type of loan, you may need to provide documentation to support your affordability like sales figures, invoices, and more. This is especially relevant if you are applying for a loan against your future sales, or your accounts receivable.
Creditworthiness
You may be subject to a credit check at one of the credit bureaus. If you have only just started your business, it might not have much credit history to speak of. In this case, your personal credit score comes into play. A fair credit history and minimum credit score may be required.
Approval
You will get notified very quickly, much sooner than with a traditional loan, if you have been approved or not. Funds are typically transferred very soon after accepting the loan terms and conditions, often within 24 to 48 hours.
Receipt of Funds
Short-term loans have shorter repayment periods than traditional business loans and often have weekly or even daily payments, such as with a merchant cash advance. But like a long-term loan, you may also have monthly repayments on your short-term loan.
Typical Interest Rates on Short-Term Business Loans
When repaying a loan, you don’t just repay the principal loan amount. You’ll typically pay interest on that amount. This is a crucial factor when applying for a short-term business loan.
Bank loans usually offer the lowest interest rates, but the eligibility requirements are much stricter. The interest rates on a short-term loan from other lenders, whether for business or personal use, tend to be higher than traditional loans.
Depending on the type of loan and the applicant’s creditworthiness, annual percentage rates (APRs) can be as low as 3% and as much as 50% or higher.
There are three primary reasons for this:
- Administrative Costs: The costs of processing and managing traditional loans are relatively fixed across monthly payments over terms that can reach up to several years. However, short-term loans are spread over a much shorter period.
- Higher Risk: Lenders perceive short-term loans as higher risk than traditional loans because short-term borrowers often have more urgent financial needs or less impressive credit histories.
- Profit Margin: Lending is a business and lenders are out to make a profit on loans. Short-term loans have a shorter timeframe in which to make a profit, so lenders may charge higher interest rates to ensure they meet their financial goals.
Interest rates on short-term loans also vary greatly depending on the lender and short-term loan type. Some have more competitive interest rates than others. For example, a merchant cash advance or line of credit may have higher interest rates than a term loan.
Some short-term business loans, like the PayPal loan, don’t carry interest, but there is still a loan fee. You also have to have a PayPal account to be eligible. To learn more, check our guide to Paypal Working Capital Loans.
Short-Term Business Loans Vs. Long-Term Business Loans
Short-term loans are shorter in duration, and typically repaid in a few weeks or months to a year. Long-term loans can have repayment terms that stretch for several years.
But there are other differences, too.
Short-term loans typically have higher monthly repayment amounts, and higher interest rates, but rarely require collateral.
Long-term business loans, on the other hand, typically have lower monthly repayment amounts and lower interest rates. They also may require collateral (although this is not always so).
Another big difference is that short-term loan amounts are generally smaller than long-term loan amounts.
That’s why the type of loan you choose will usually depend on what you need funding for. Short-term loans are suitable as small business loans that address emergency expenses or opportunities. Meanwhile, long-term loans are ideal for business acquisitions, long-term investments, and projects.
Types of Short-Term Loans
Different businesses have different needs. And that means they have different requirements when it comes to financing, too. Fortunately, there are different types of short-term loans to meet their unique financial needs.
Merchant Cash Advances
If a bad credit score is preventing you from qualifying for other loans, a merchant cash advance may be the solution. A merchant cash advance is a short-term loan that advances a business’s cash to use for working capital, inventory costs, and other business expenses.
The borrower repays the amount with regular payments based on a pre-agreed percentage of sales, plus a small loan fee. These are usually monthly payments, but they can also be weekly or even daily.
There are similar short-term loans available on the Amazon Lending program. If you are an Amazon seller, you may be interested in that option. Read our guide to Amazon Loans to find out more.
Lines of Credit
Have you had no success applying for a business credit card? A business line of credit is a short-term loan that operates much like a credit card. It has a preset borrowing limit and the borrower can draw on the funds at any time until that limit is reached. Interest is only payable on the funds used.
A line of credit allows you to draw funds only when you need them. This is very convenient, but take note that a line of credit usually does not extend indefinitely like a credit card would.
Payday Loans
A payday loan is a short-term loan that offers small loan amounts paid back with the borrower’s next paycheck. Payday loans are typically high-cost and subject to payday lending state statutes in the U.S.
They are also unavailable in some U.S. states. For example, they are prohibited in the District of Columbia and several states, including Arizona, Arkansas, Georgia, and North Carolina. If you live in one of these states, you will have to look for another short-term loan option. But even where payday loans are allowed and are available, restrictions may apply.
Online or Installment loan
You can get a short-term loan online that you pay off in equal monthly payments. This is called an installment loan.
Personal loans are a type of installment loan, but not all installment loans are personal loans. An installment loan typically has an origination fee, which is a set percentage of the approved loan amount. Online lenders typically process applications and distribute funds much faster than traditional lending institutions.
Online installment loans are quick and easy to apply for, and several online lenders cater to individuals and businesses with poor credit scores. But be aware that they typically charge higher fees and interest rates in such cases.
Invoice Financing
Invoice financing is a type of short-term loan designed for businesses. As the name suggests, it allows businesses to borrow funds against the amounts due from customers. This is sometimes referred to as accounts receivable financing.
When your customers/other companies purchase from your business on credit, you give them an invoice with the total amount due. If you need funds before those invoiced amounts are due, you can apply for invoice financing.
It is expected that those customers will pay in due course, therefore the invoiced amounts will cover the loan. As such, the invoices act as collateral. Of course, there is always the risk that some customers will not pay, which is why lenders don’t usually advance the full invoiced amount to the borrowing business.
Advantages of a Short-Term Loan
There are numerous advantages of short-term loans:
- They are quick and easy to apply for, especially when everything is done online. The initial short-term loan application often takes only a few minutes.
- Even though documentation may be required, it will probably be less than you’d have to produce for a long-term loan at a bank.
- You won’t have as long a wait to hear if you’re approved, as with some traditional lending institutions.
- Funds are often paid to you in 1-2 days. This means you can meet your most urgent financial challenges head-on before they become more difficult to solve.
- There are different types of short-term loans, with varying levels of flexibility. You’re sure to find one that can work for you.
Drawbacks of a Short-term Loan
Unfortunately, there are a few drawbacks to short-term loans, too:
- A short-term loan is designed to deal with financial emergencies, unexpected business opportunities, and working capital shortfalls. Therefore, the loan amounts are not usually very high.
- You have a shorter period in which to repay the loan than you’d have with a traditional loan. Because of that, your repayment amounts may seem high, and you may also feel more pressure to get the loan paid off.
- The interest rates are often much higher than with conventional loans. Not all short-term business loans carry interest. Some have only a fixed loan origination fee. But when they charge interest, it will likely be higher than that of a longer-term loan.
Why a Small Business May Need a Short-Term Business Loan
The beauty of short-term loans is their versatility. They can address a great number of business needs, for both startups and established small businesses.
If you have a startup business, you may be constantly surprised by unexpected (and unplanned) business expenses. This is common during the teething stage of any business. A short-term loan can help you get through these challenges.
But even a small business that has been operating for years, may experience a financial setback. Equipment can fail, or perhaps it simply doesn’t meet your needs now that you’re scaling the business. Or you might be going through a rough patch, and need help with running expenses.
Which Short-Term Business Loan Option Is Right for Your Business?
The key to choosing the right loan is to know which of the many types of short-term loans is right for your business.
Determine Your Business’s Financial Needs
Consider what you need the money for, and how much you need. If you need to buy equipment, for example, get quotes from several suppliers. If you need to hire temporary staff to deal with an upcoming event, what is the total you need to pay their wages?
Some financial obstacles are more complex, and cost more to solve, than others. If you run late with repayments, you don’t want to compound the issue with penalties. So look for a loan that does not penalize you for late payments.
If you are certain that your expected short-term revenue will more than cover your loan repayments, consider a merchant cash advance, or invoice financing. Are you simply trying to cover running expenses or get some extra inventory? A line of credit may be the answer.
Calculate Your Loan Affordability
Calculate what sort of loan you might be able to afford. You can use a business loan calculator and enter the loan amount, interest rate, and loan term of the typical short-term loan you are considering.
Next, review your business’s monthly cash flow. In the case of a loan with weekly repayments, assess your weekly cash flow. Does your revenue consistently exceed your expenses? Will it do so when you factor in the new loan repayments?
This will determine if your business can afford to make the loan payments without straining finances even more. Of course, you may be taking the loan to make changes that will bring in more revenue. If that is the case, calculate how much extra revenue you can realistically expect during the loan term.
Plan For the Unexpected
If an unexpected drop in sales is what puts you in financial peril, it could happen again. And you won’t be able to pay your loan back. So, be realistic about your situation. Consider how you will cope in different scenarios, such as a drop in revenue or unexpected expenses.
If you believe you will manage the loan repayments, even under less than favorable conditions, go for it. If not, consider a smaller loan, or if necessary, scaling back your business plans until you have the funds you need through sales.
Avoiding debt that you cannot repay is just good business sense. It will be better for your business to have a minimal credit history than to be listed as a non-payer.
Typical Requirements to Qualify for a Short-Term Business Loan
Online lenders that offer short-term loans for businesses often have less stringent qualifying criteria than banks and traditional lenders. However, they do have some basic requirements.
The most common ones are:
- The borrowing business must have been operating for at least a year. Brand new businesses are seen as a higher risk, as they don’t have much of a credit history or credit score yet.
- A minimum business credit score. Every lender will have their own minimum that they allow. Although it is possible to get a short-term loan with a lower score, the interest may be high to compensate for the lender’s risk.
- Proof of ability to repay the loan, and a commitment to a minimum /periodic payment. A positive cash flow that shows the borrowing business earns more than it spends will improve the odds of the loan being approved.
- Minimum annual revenue — this amount can differ depending on the lender and the loan amount. It could be anywhere from $10,000 to $20,000.
How to Get a Short-Term Business Loan
Wondering how to get a short-term loan for your small business? It’s really simple. You can apply for any of the above loan types online. But you’ll need a few things first.
Ensure you have any relevant information to hand, such as your Social Security Number, and Employer Identification Number (EIN). The EIN is the unique nine-digit number assigned by the IRS to identify your business entity. Know how much money you need, and how you plan to pay it back, before applying.
Final Thoughts
Short-term business loans help small-to-medium-sized businesses overcome their immediate financial hurdles.
Whether it’s a shortfall in working capital, a new business expansion opportunity, or an unexpected equipment failure, short-term business loans are the solution. With so many different short-term solutions, there’s a loan for every need and every business type.
Are you looking for a short-term loan that suits your small business’s needs? Our team at E-Boost Partners can help! We offer easier access to small business financing solutions like working capital loans, lines of credit, and other merchant services.
Contact us today for more information about short-term business loans and our services.
