Growing a business and expanding your operations often requires financial investment. Many small and medium-size businesses take out business loans to purchase new inventory, upgrade equipment, or take any other number of steps to help them scale.
And for many businesses, short-term lending looks like the more appealing option since it’s often easier to attain than longer-term and more significant.
But before opting for short-term lending, it’s important to understand the pros and cons and to make an informed decision about whether it’s right for you.
What is Short-Term Lending?
Short-term lending includes any loan that’s repaid in a matter of a few months to a few years, typically offered by loan agencies rather than banks. And unlike long-term bank loans, short-term lending is often easier to get.
However, it also generally comes with high interest rates that can come with negative financial implications if you’re not careful.
Let’s look at the pros and cons of short-term lending to help you see if it’s a good option for your business.
Pros of Short-Term Lending
There’s a reason small businesses often go to loan agencies—it’s convenient. Getting a long-term business loan from a bank or financial institution can take a long time, have strict requirements that are especially challenging for newer businesses, and be a complex process.
Short-term lending is typically:
With a short-term loan, you’ll typically receive your money in just a few business days. This allows you to invest that cash into your business right away.
Unlike banks that do extensive background checks or may require interviews, short-term lending is designed to be easy. Paperwork is simple and can often be done online.
Banks can have strict requirements to approve loans, but short-term lenders generally do not. This means that businesses with lower credit history can still qualify for a loan.
Since short-term loans are relatively easy to get, most businesses will be approved easily and you’ll have cash in hand quickly, allowing you to address business challenges and opportunities immediately.
Cons of Short-Term Lending
The pros of short-term lending seem too good to be true… and in some ways, they can be. That’s because short-term loans have one significant downside that should make you think carefully: incredibly high interest rates.
Compared to long-term loans from banks or financial institutions, short-term loans have high APRs (annual percentage rate), ranging anywhere between 7% to 99%, in extreme circumstances. This means that you can end up paying significantly more for your loan than you ever intended to, particularly if it takes you longer to pay it back.
A simple business loan calculator helps illustrate this point.
Let’s say you need a $25,000 loan to upgrade some of your equipment. You intend to pay it back within one year. What does that look like in terms of interest?
- Short-term loan from a loan agency at an APR of 25% = total loan repayment of $28,513; total interest paid is $3,513.
- Traditional bank loan at an APR of 5% = total loan repayment of $25,682; total interest paid is $682.28.
In this example, a short-term loan could cost you five times more interest than a traditional loan. And while it may be worth it for a one-off loan when you need fast access to cash, these high interest rates add up quickly.
There are two other notable cons to short-term lending:
1. Frequent payments
Many short-term loans require weekly payment installments, which can be challenging to keep up with.
2. Debt cycles
Because short-term loans are so easy to get, some businesses start to rely on them to keep their operations afloat. This can quickly get you into a debt cycle that’s hard to come out of.
Key Considerations: When to Use Short-Term Loans
Short-term lending is, no doubt, quick and convenient. It can be a great way to infuse some extra cash into your business to grow or maintain operations. But you’re going to be paying for that convenience.
So, is short-term lending right for you? Well, it depends.
There are two scenarios in which short-term loans may be a good choice:
- Emergency situations where you need quick cash to resolve a problem (e.g., a key piece of equipment broke down and you need to purchase a new one to carry on operations).
- Specific projects or goals where you’ve defined what the money will be used for, how you’ll pay it back, and will confine the loan funds to the one specific scenario.
- When you’re able to pay back the loan quickly to drastically reduce the amount of interest you’ll be hit with.
- If your company has reliable methods for repaying debts and a quick cash-flow cycle, short-term lending might work for you.
But, before you take out a loan of any sort, be sure to talk to a financial professional who can help advise you of the best course of action. You may find you’re better off exploring other options, like grants, fundraising, or general business mentorship. The Small Business Administration and US Government Small Business Support page are good places to start!
There’s also a ton of value in being part of a professional network that can help you grow your knowledge. Places like coworking spaces put you among a ton of other professionals like yourself who can provide their insights and share their experiences with the options you might be mulling over.
So, if you’re looking for a professional network and an incredible flexible workspace, book a tour of your local Launch Workplace today.