An In-Depth Guide to Short Term Loans

Jun 18, 2019

An In-Depth Guide to Short Term Loans

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Term loans are extremely popular in America. In fact, you probably have used them in the past to purchase a vehicle or home. The setup is simple—you borrow a specific amount of money and then pay it back over a period of time. Those terms vary from loan to loan, but they’re usually between 1 and 5 years.

Regular term loans are versatile, with amounts ranging from $2,000 to $5,000,000. The interest rates also vary widely—from 6% to 99%. And you can use a term loan for a wide array of business needs, unlike other types of financing with strict limitations.

But what about those times when you need money fast? Perhaps there’s a new business opportunity you can’t pass up. Or a project that needs immediate attention. In these times, you want the benefits of a term loan but on a shorter timeline.

This scenario is where short term loans come in. They’re like the sprinters of the financing world. When you don’t have time for a marathon-like term loan, this loan type is always a solid option.

The Nuts and Bolts of a Short Term Loan

Because they’re built for speed, short term loans are smaller than term loans in just about every sense. The amounts usually don’t exceed $500,000, and the terms only last a few years. Most importantly, you’ll get your money in as little as 24 hours. It’s one of the all-time fastest ways to obtain funding.

You can expect to pay a bit more for a short term loan, given its expedited timeline. The interest rates start in the neighborhood of 8%, which is still a borrower-friendly rate. Traditional and non-traditional lenders both provide short term loans, giving you more options as you’re trying to find the best fit for your business.

Because convenience is a hallmark of short term loans, it’s not surprising that it’s fairly easy to qualify. A lender will look at your credit and make sure it’s solid. As long as you have a score of 650 or above, you should be in good shape. Also, your business will need to be operating for at least 2 years.

It’s worth noting that you might also need to provide collateral on some short term loans. Small business owners often use vehicles, real estate, or homes as collateral in these situations.

How to Use Your Short Term Loan

You can use a short term loan for all manner of business needs. They’re like the Swiss Army knives of the financing world. But it’s recommended that you only seek one when time is of the essence. If you have a longer timeline, it’s probably better to get a term loan instead, due to the lower interest rates.

Small business owners often use short term loans to cover unexpected expenses, seize a business opportunity, manage cash flow, hire staff, or to get their hands on some working capital. If you need to repair or replace crucial equipment, a short term loan will help you get the money you need in a hurry. However, it also has another benefit when it comes to equipment.

“If a business needs to finance new equipment, a short term loan would make more sense than a longer-term loan,” explains AuburnPub.com. “You don’t want the term of the loan to be longer than the working life of the equipment.”

How Much Do Short Term Loans Cost?

As you review your business loan options, you’ll be able to narrow down your top contenders based on how much they will cost. It all comes down to stacking the comparable elements against one another. Be aware that lenders sometimes include hidden fees—keep a sharp eye out for extras like early repayment fees, processing fees, or late fees.

“While there are numerous options from which to choose, not all deliver the same benefits,” warns Tom Coletta of Axiom Bank. “Make a short list of potential lenders by shopping around to compare offers. As you go through the process, keep in mind that bigger isn’t always better—or safer.”

The ultimate goal is to find the short term loan you feel confident and comfortable with. Here are 4 popular pricing metrics you can use to narrow down your different options:

  1. Cents on the Dollar: This basic metric reveals how much money you’ll pay in interest and fees for every dollar borrowed.
  2. Average Monthly Payment: This helpful metric breaks down the cost in monthly terms. Even if your loan has daily or weekly payments, you can calculate this metric.
  3. Annual Percentage Rate (APR): This common metric shows how much the loan will cost you each year.
  4. Total Cost of Capital (TCC): To get the full picture, this metric adds in all of the interest and fees.

Even with these comparison metrics, it can be difficult to figure out which short term loan options are the best because lenders often list disclosures differently, making it difficult to compare apples to apples.

The Innovative Lending Platform Association worked with some of the most trusted lending platforms in the industry to help solve this issue. They created a tool called SMART Box™ (Straightforward Metrics Around Rate and Total cost) that provides you with user-friendly pricing metrics and calculations.

“Access to capital is a top priority for NSBA and we appreciate how SMART Box allows small businesses to more fully assess and compare lending options,” explains Todd McCracken, president and CEO of the National Small Business Association. “This type of price transparency, along with best practices like the ones adopted by the Coalition for Responsible Business Finance (CRBF), will help solidify the trust between non-bank lenders and small businesses.”

How to Apply for a Short Term Loan

When you’ve identified the best loan for your business, it’s time to apply. While you may feel pressure to get the money as soon as possible, don’t let that drive you to do a shoddy job on the application. It’s always a good investment to take the time to thoroughly review the requirements and do everything right the first time.

First, assemble all the documentation the lender requests. Providing the right documents in your application is an easy way to demonstrate your reliability to a lender. While the document requirements are different from lender to lender, here’s a list of things you might need to collect:

  • Personal background information such as education history, previous addresses, names you’ve used, and criminal record
  • Your resume
  • An airtight business plan with proof of cash flow, profit and loss, and balance sheets from your business
  • Credit reports
  • Business and personal tax returns from the past few years
  • Signed personal financial statements
  • Projected financial statements
  • Business and personal bank statements from the past year
  • Value of collateral that may be required
  • Business licenses and registrations related to your business
  • Any franchise agreements, commercial leases, articles of incorporation, or copies of third-party contracts

How a Lender Decides to Approve Your Loan

Your personal and business credit will be an important element of any lender’s decision. At its core, a credit score is an algorithm that can help predict whether or not you’ll repay the money you borrow. So it’s one of the handiest tools a lender has at their disposal.

Here are 5 other factors lenders will usually analyze before giving you a short term loan:

  1. Personal debt ratio
    If you’re carrying personal debt, don’t worry. The vast majority of Americans do. What matters is how much of your available credit you’re using. Lenders divide your outstanding debt by your available credit to see if they can trust you with their money.
  2. Business debt
    Lenders will be keenly interested in how much debt your business currently carries. If it’s similar to other businesses in your industry, you should be in great shape. But if you’re on the heavier side of borrowing for a business of your size, lenders may begin to have second thoughts on your application.
  3. Business revenue trends
    Where your business is headed is important to lenders. While it’s impossible to predict everything that’ll happen, they’ll want to evaluate your average revenue growth and see how it compares to your industry’s average. If your business is in the middle or upper tier, lenders will be much more optimistic about which way your business is trending.
  4. Personal debt coverage
    It’s natural to want to know the spending habits of someone you’re lending money to. So lenders will often look at your debt coverage to see if you’d be able to personally make the necessary payments if your business began to struggle.
  5. Business debt coverage
    It’s no problem if your business has debt, but lenders will want to know how you handle that debt. By evaluating your cash flow and debt payments, lenders will decide whether or not you’re likely to make your payments on time.

Improve Your Chances of Getting a Short Term Loan

Did you know that most loan requests are rejected? That sounds harsh, but you probably operate on a similar scale in your personal life. Think of the last few friends or family members who asked to borrow money from you. You may have lent money to some, but most likely, you politely turned down the majority of requests.

When one of your loan applications is inevitably rejected, don’t take it personally. Instead, try to learn from it and see where you can improve your standing for the next time you apply.

As mentioned earlier, your personal and business credit scores are crucial elements for most loan approvals. First, a healthy score helps convince a lender that you’re a trustworthy recipient of their money. Second, it can help you qualify for more favorable terms and interest rates. In this way, a strong credit score can easily save you thousands of dollars over the life of your loan.

Perhaps your credit scores aren’t where you’d like them to be. You can start remedying that by being proactive. Monitor your scores regularly and look for ways to improve. One of the easiest ways to do this is to correct errors on your reports. About 1 in 5 Americans have errors on their reports, so there’s a decent chance something is amiss on yours. If you clean up those mistakes, you’ll quickly see a boost in your score.

Also, consider signing up for automatic payments whenever that’s an option. Your life is hectic and missing the occasional payment is all too easy. By automating payments, you can reduce the likelihood of negative factors on your score. If you can’t find a way to make a specific payment automatically through a payee’s website, add them as a regular payee through your bank’s system.

The bottom line is that you hold a lot of power when it comes to your short term loan. True, lenders will make the final decision, but if you do everything you can to boost your credit scores, do your due diligence before applying, and submit all the requested documents, you’ll provide them with a short term loan request that’s hard to deny.

About the Author

Grant Olsen

Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.

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