Short term loans

What Is a Short-Term Loan?

Applying for a business loan should never be taken lightly. However, depending on your business’s financial needs, a short-term loan might be an attractive option.

Often, one of the most challenging parts of starting a business is securing enough money to get the ball rolling. But, unfortunately, 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. So instead, many consider researching and applying for a short-term loan.

loan tips melborne

 

A short term loan is a type of loan that is obtained to support a temporary personal or business capital need. It is a type of credit that involves repaying the principal amount with interest by a given due date, which is usually within a year from getting the loan.

A short term loan is a valuable option, no bank statement payday loans for Australian citizens, especially for small businesses or start-ups that are not yet eligible for a credit line from a bank. The loan involves lower borrowed amounts, which may range from $100 to as much as $100,000. Short-term loans are suitable for businesses and individuals who find themselves with a temporary, sudden cash flow issue.

Characteristics of Short Term Loans

Short term loans are called such because of how quickly the loan needs to be paid off. In most cases, it must be paid off within six months to a year – at most, 18 months. Any longer loan term than that is considered a medium-term or long term loan.

Long term loans can last from just over a year to 25 years. Some short term loans don’t specify a payment schedule or a specific due date. Instead, they simply allow the borrower to pay back the loan at their own pace.

Understanding Short-Term Debt

There are usually two types of debt, or liabilities, that a company accrues—financing and operating. The former results from actions undertaken to raise funding to grow the business, while the latter is the byproduct of obligations arising from normal business operations.

Financing debt is normally considered to be long-term debt in that it is has a maturity date longer than 12 months. Therefore, it is usually listed after the current liabilities portion in the total liabilities section of the balance sheet.

Operating debt arises from the primary activities that are required to run a business, such as accounts payable. It is expected to be resolved within 12 months or its accrual within the current operating cycle. This is known as short-term debt and is usually made up of short-term bank loans taken out or commercial paper issued by a company. 

The value of the short-term debt account is very important when determining a company’s performance. Simply put, the higher the debt to equity ratio, the greater the concern about company liquidity. If the account is larger than the company’s cash and cash equivalents, this suggests that the company may be in poor financial health and does not have enough cash to pay off its impending obligations.

The most common measure of short-term liquidity is the quick ratio which is integral in determining a company’s credit rating that ultimately affects that company’s ability to procure financing.

Types of Short Term Loans

Merchant cash advances

This type of short term loan is actually a cash advance but one that still operates as a loan. The lender loans the amount needed by the borrower. The borrower makes the loan payments by allowing the lender to access the borrower’s credit facility. Each time purchase by a customer of the borrower is made, a certain percentage of the proceeds is taken by the lender until the loan is repaid.

Lines of credit

A line of credit is much like using a business credit card. First, a credit limit is set, and the business is able to tap into the line of credit as needed. Then, it makes monthly instalment payments against whatever amount has been borrowed.

A line of credit is a loan wherein a bank or financial institution sets a maximum loan amount that an individual can borrow. The borrower has the flexibility to withdraw the loan amount in a lump sum or instalments. Borrowers cannot withdraw beyond the permitted limit, which is determined based on their creditworthiness.

In return, the bank charges only on the withdrawn amount and not the remaining available balance of the loan. When it’s time to pay the dues, the borrower will not be able to withdraw until the due principal and interests are paid. After paying the dues, the borrower can resume using the line of credit service. LOC works best when one requires a regular supply of credit.

Therefore, monthly payments due vary following how much of the line of credit has been accessed. One advantage of lines of credit over business credit cards is that the former typically charge a lower Annual Percentage Rate (APR).

 

Payday loans

Payday loans are emergency short term loans that are relatively easy to obtain. Even high street lenders offer them. The drawback is that the entire loan amount, plus interest, must be paid in one lump sum when the borrower’s payday arrives.

Repayments are typically made by the lender taking out the amount from the borrower’s bank account, using the continuous payment authority. As a result, payday loans typically carry very high-interest rates.

Online or Installment loans

It is also relatively easy to get a short term loan where everything is done online – from application to approval. Then, within minutes of getting the loan approval, the money is wired to the borrower’s bank account.

Invoice financing

This type of loan is done by using a business’s accounts receivables – invoices that are, as yet, unpaid by customers—the lender loans the money and charges interest based on the number of weeks that invoices remain outstanding. When an invoice gets paid, the lender will interrupt the payment of the invoice and take the interest charged on loan before returning to the borrower what is due to the business.

Bank Overdraft

A bank overdraft is one of the most common types of credit facility. Under this service, if bank account holders have insufficient money in their account than the amount they are trying to withdraw, the bank will provide the rest. In return, the bank charges interest with some setting exorbitant rates.

Businesses have innumerable transactions every day, leading to a fast-falling bank balance. A bank overdraft service avoids operational interruption due to rejected payments on account of a low balance. However, customers need to exercise caution when using bank overdrafts. Some reputed providers have charged unaccrued interests from their customers. Often, these banks have paid millions in fines for such illegalities.

managing loans

Why should you avoid short-term loans? 

Short-term loans should be used only as a last resort to cover expenses that must be paid where you have no other alternatives.

Interest rates and fees

The interest rates on these loans are often very high. For just a few thousand dollars (most lenders won’t offer much more than $10,000 or $15,000 at most), the borrower could be on the hook for an APR approaching 400 per cent or more.

Lenders expect their money to be paid back quickly—certainly within a year, usually in just a month or two weeks. You need to make sure you have a solid plan to pay it back within the loan terms because the consequences can cost you even more. If you cannot repay the principal within the allotted terms, sizable late fees begin to accrue.

Credit score penalties

These loans may also affect your credit score, both positively and negatively. Some companies make what is called a hard inquiry on your credit, and your credit will take a slight hit for that. Additionally, your credit will also be negatively affected if you miss a payment or don’t pay off the loan in time.

Potentially hazardous cycle

The biggest drawback to short-term loans is that often they do not adequately solve the underlying problems that cause you to need a short-term loan. In fact, with their high-interest rates and fees, they often make the problem worse.

You have to pay the interest and fees to get the short-term loan, so you have less money next month, which makes it even more likely you’ll need another loan. It’s a vicious cycle that’s difficult to escape.

Advantages

  • Avenue for Small Loans: People don’t necessarily have to take a mortgage loan when they are in need of some immediate cash. A short-term credit facility allows people to arrange a small amount of money from financial institutions for needs such as medical emergencies, or business expenses
  • Faster Approval: Short-term loans do not require lengthy approval processes as compared to other forms of loans.
  • Lower Accrued Interest: As the repayment period is shorter, the amount of interest paid by the borrower is lower.
  • Increases Credit Score: Availing such a loan and paying it off without any default can help increase the borrower’s creditworthiness.
  • Unsecured: Such loans are usually unsecured, and borrowers do not require any collateral, making it easier to acquire funds at short notice.
  • Economic Well-Being: The interest rates on inter-bank overnight borrowings are essential tools for central banks to control inflation or deflation. This is because an increase or decrease in short-term lending rates eventually affects the borrowing cost of kinds of all loans. When a central bank intends to increase growth, it lowers interest rates, increasing investment and consumption, leading to higher GDP, wages, and employment.

Disadvantages

  • Lower Borrowing Amount: Sometimes, the borrower may require a larger amount which cannot be availed under short-term credit.
  • Small-time Borrowers Plight: Several payday loans charge up to 400% interest in a year. High APRs make it difficult to manage repayments for those with humble means. Any interest rate hike or penalties may cause a further strain, resulting in default and subsequent lower credit scores.
  • Unfair Means: Over the years, many paydays and credit card lenders have made headlines for harassing their debtors. According to a 2020 study, over 3000 borrowers were issued an arrest warrant over payday loans, vehicle title, and another expensive lending.
  • Credit Score: Due to the unsecured nature of the loans, those with low credit scores often struggle to acquire funds from reputed sources. With years many short-term loan providers have surfaced who provide loans to those with a bad credit score. They charge heavy interest rates to compensate for the lack of creditworthiness. With more expensive loans, the chances of default increase which can further damage the credit score.

knowing loans

FAQs

What is an example of a short-term loan?

An example of a short-term loan is a bank’s overdraft facility. Under this scheme, if the borrower’s account holds insufficient funds to make a payment, the bank extends additional funds. In return, the bank charges the borrower for the service.

How can I get a loan for a short time?

There are many avenues to get a loan in a short time, one being many banks providing an online facility to apply for the loans. If approved, some personal loan providers can lend money within 24 hours. In addition, some institutions provide attractive rates to those with a high credit score.

What is a short-term loan?

People don’t necessarily have to take a mortgage loan when they immediately need some cash. A short-term loan allows people to arrange a small amount of money from financial institutions for needs such as medical emergencies or business expenses. The loan amount is small, and maturity is usually a year long.

Is a short term loan good?

Short term loans are very useful for both businesses and individuals. For businesses, they may offer a good way to resolve sudden cash flow issues. For individuals, such loans are an effective source of emergency funds.

Why is short term financing risky?

Reputational risk is the main concern for short-term finance, especially if borrowers have pending environmental and social issues that are highly visible and scrutinized by the public. However, due to the short-term nature of the transaction and the use of collateral, the credit risk to a financial institution is limited. 

Scroll to Top