What Is a Short-Term Loan?

Discover the nuances of short-term loans, understanding their benefits and considerations, to decide if they're the swift financial solution your business or personal needs demand.

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One of the biggest struggles for many new business owners lies in securing the funds for their companies. Entrepreneurs often have capital needs associated with their startups, such as:

  • Securing any tools and software needed for the job
  • Costs associated with filing paperwork
  • Paying for insurance
  • Investing in any product development needed for the business

If you’re starting a business, the United States Small Business Administration (SBA) offers a calculator that you can use to determine your likely expenses and how much you need to budget. However, the average cost of starting even a microbusiness typically runs about $3,000. Businesses may find themselves in need of a rapid supply of cash if they fall short of their projected income or encounter other challenges in their early days of running a business.

Entrepreneurs who need additional funds to operate may look toward a short-term loan. A short-term loan can be a good option for businesses needing small amounts of cash very quickly.  These loans can range from $5,000 to $300,000 and are typically due for repayment by the borrower in a shorter period of time compared to longer-term loans.

For small business owners, one of the biggest benefits lies in the ease of securing these loans. Generally, people just starting businesses might not have the same eligibility for a line of credit that a more established entrepreneur does. Therefore, this type of loan empowers small business owners to secure the funds they need to run their companies. 

What are the types of short-term loans?

If you are a new entrepreneur considering pursuing a short-term loan, you should familiarize yourself with the main types of business loans. This will help you determine the loan that will work best for your business needs. 

Merchant Cash Advances

A merchant cash advance operates uniquely. If you need to borrow a certain amount of money, you’ll repay the lender through the sale of your products and services. With this type of loan, the lender will give you the money, and in return, you owe them a percentage of your sales until you finish repaying the loan. 

Since these loans are repaid with a percentage of the sales, most lenders will require you to accept credit card payments so that they can access their funds. If your business processes a high number of credit card sales, and you just need a quick lump sum of money for particular expenses, this might be a good option for you. However, you should consider potentially high interest rates and the obligation to make payments based on sales percentages, which may hinder cash flow.

Lines of Credit

A business credit line functions similarly to a credit card. The business gets approved to borrow up to a certain credit limit. When they use some of the credit, they’ll have a monthly payment due based on the amount borrowed and the interest rate. 

This option appeals to many business owners, as it can be possible to secure a lower annual percentage rate (APR) on a line of credit versus a business credit card. They also cost less than other forms of short-term loans, making them an attractive option for those needing money quickly but don’t have high profit margins. However, securing this type of funding is generally more difficult than other options.

Payday Loans

Payday loans work as a type of emergency funding. They can be very easy to obtain, but they are generally due in one lump sum — including the interest — when the borrower’s payday arrives. These loans also often carry high-interest rates. 

These loans often work best for those who generally turn enough profit that they feel confident in their ability to pay off the loan.

Online or Installment Loans

With an online or installment loan, you can fill out the loan application online and quickly secure the funds you need for your business right into your bank account. The duration of these loans can be as short as only two weeks. With an installment loan, you agree to pay back the loan in fixed installments. These loans can be relatively easy to apply for and receive, thanks to the online application, but some do come with high interest rates that borrowers need to be wary of.

Invoice Financing

Invoice financing, also known as accounts receivable financing, allows businesses to secure funds based on the outstanding invoices their customers or clients haven’t paid. This option works well for any business owner who has a lot of money tied up in unpaid invoices. This lack of cash flow can make it difficult for the business to continue to grow and take care of basic tasks, such as paying insurance or office rent. 

With invoice financing, the borrower essentially sells the invoices to the lender to get access to the money owed. The loan will be for a certain percentage of the amount owed on the invoice. When the customer pays, the loan amount and fees go to the lender, and the rest goes to the company.

These loans can be easily qualified for, as companies use their existing invoices as collateral. For service-based businesses that might have accumulated unpaid invoices, this option also can help keep money flowing through the organization. However, businesses can miss out on the full extent of the money owed since the lender collects fees.

What type of short-term loan is best?

It’s important to realize that the best type of short-term loan will depend on you and your business needs. An entrepreneur starting a copywriting business versus one starting an electrician business will have very different needs, which means they might want to pursue different types of loans. You should consider what you need from a short-term loan and review the terms that fit your business.

As you begin to consider the different types of loans that might fit your organization, you’ll find that short-term loans offer several benefits that can help keep your business running.

Less Time for Incurring Interest

With a short-term loan, you begin to repay the loan fairly quickly after borrowing it. Short-term loans will be repaid within 18 months at the longest. This short repayment period means there is little time for interest to accumulate. Since short-term loans tend to have higher interest rates than other types of loans, this can help business owners avoid too much interest. With the other financial stressors that new entrepreneurs face, you want to carefully control the amount of interest you accumulate.

Rapid Funding

With a short-term loan, businesses can obtain rapid funding to build their working capital. At times when building a business, you may find that you need money quickly. Short-term loans often get approved faster than other types of loans because the approval process is not as intense. 

Since the borrower will reach the maturity date of the loan relatively quickly, the lender feels more confident in what the business owner’s financial situation will be when loan payments begin. This speeds up the process.

Easy Acquirement

Short-term loans have various traits that make lenders more comfortable offering them. Since the loan is for a smaller amount and gets repaid quickly, the lender will generally not require as much of an arduous approval process as you might encounter on larger or longer-term loans. Therefore, these loans are easier for new entrepreneurs to acquire. New businesses often don’t have stable assets or excellent credit scores required to secure a different type of loan. For small business owners without access to a bank loan, this makes short-term loans an excellent solution.

Let a short-term loan help your new business

When just starting, you might need to secure new forms of funding to build your new business. Regardless of your industry, you may find that short-term loans offer you the best opportunity to get the funding you need. Consider if any of these financing options sound appealing to you.

As you begin to face the paperwork that comes with creating a business, take advantage of the resources at ZenBusiness. We want to make the formation process easy so that you can grow your business with confidence.

Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.

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Written by Team ZenBusiness

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