This guest article was provided to us by Emily Kate Pope. Emily Kate Pope is the Managing Editor at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. She specializes in all things small business finance, from lending to accounting.
When it comes to small business financing, sometimes you need access to working capital more quickly than a traditional bank loan can offer. And while there are many short-term financing options available, they’re often thought to be dangerous.
You’ve likely heard the horror stories. Greedy lenders and high-interest rates can lead business owners to crushing debt, with an even bigger issue on their hands than the short-term loan was meant to fix in the first place.
However, not all short-term business loans are created equal. In fact, if you do your research, read the fine print, know what you’re getting into, and are a responsible borrower, a short-term loan could mean great things for the future of your company.
But remember, even though short-term loans can be easy to qualify for, they can also be costly. Here are some of the major pros and cons that come with taking out a short-term business loan.
Pro: Generally Easy Approval Process
Long-term loans, and SBA loans, in particular, are extremely sought-after forms of business funding due to their low-interest rates and low monthly payments. However, they are also difficult to qualify for.
If you have poor credit history, low annual revenue, or haven’t been in business for that long, it’s less likely that you’ll be granted a long-term loan. That’s where short-term loans come in. There are many different types of short-term loans available, many of which accept borrowers with a low credit score or little business experience.
Additionally, the approval process for short-term loans mostly takes place online. That means you can apply for funding anywhere, at any time — and potentially gain loan approval within a matter of days, or even less time. The paperwork is also limited, which means you won’t have to spend as much time preparing your loan application.
Con: Higher Interest Rates & Frequent Payments
The quicker and more lenient approval process that comes with a short-term loan is thanks in large part to its much higher interest rates. You’ll likely be paying much more over time than you would for a long-term loan. And if you think about it from the lender’s perspective, it makes sense. They are taking on more risk by funding a less-than-perfect borrower.
Additionally, short-term loans may come with terms that require you to make payments on a daily or weekly basis. If you’re seeking a loan because your business is experiencing revenue problems, this could prove to be an issue. Have a good handle on your projected revenue and growth before you inadvertently sign up for a short-term loan you can’t pay back.
Certain businesses, like retail stores and restaurants, have enough cash coming in daily that making the frequent payments back on a short-term loan is completely manageable. However, if your business depends on bigger payments that take time to come in, you might want to seek funding elsewhere.
Pro: Increased Cash Flow
One of the biggest reasons business owners apply for a short-term loan is the quick access they can get to working capital. If you are currently experiencing cash flow problems, this can provide your business some much-needed relief.
For example, say you’re waiting on invoices to be filled, but need to pay your rent and cover other expenses in the meantime. Short-term financing can cover those costs while you wait for revenue to come in.
Con: The Risk of Being Sucked into a Debt Cycle
If you’re taking out a short-term loan, it likely means you need money. But what happens if the time comes for you to start paying back your loan, and you still need money?
You may end up needing to take out another short-term loan to pay back your first short-term loan. And then, when you can’t pay that loan back…the cycle simply continues. Certain less-reputable lenders prey on this, so do be careful. And if you’re ever refinancing your debt, try to do so with a long-term loan rather than short-term one.
Pro: Access to Opportunities
Any small business owner knows that the biggest opportunities come at the most unpredictable times. If you’re faced with a major opportunity for growth, but didn’t have enough warning to prepare financially, gaining access to capital could make all the difference for your business.
A short-term loan can help you grab onto an unprecedented opportunity that you wouldn’t be able to otherwise. If the opportunity is one that’s going to generate more revenue for your business, that will put you in a good position to be able to pay the loan back in a timely manner.
When to Go After a Short-Term Loan
While there are plenty of situations where a short-term loan just doesn’t make sense, there are also plenty of others where one is the best option. By first assessing your level of risk, you can determine whether it’s a good bet for your business. If you know you can and will pay back your short-term loan on time or are going after a revenue-generating opportunity, a short-term loan may just be the right move.