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Short Term Loan

A type of loan used to support a temporary personal or business capital need

What is a Short Term Loan?

A short term loan is a type of loan that is obtained to support a temporary personal or business capital need. As it is a type of credit, it involves a borrowed capital amount and interest that need to be returned or paid back at a given due date, which is usually after a year from making the loan.

 

Short Term Loan

 

A short term loan is a valuation option, especially for small businesses or start-ups that are not yet eligible for a credit line from a bank. The loan also involves lower borrowed amounts, which start from $100 to as much as $100,000. Short term loans are suitable not only for businesses but also for individuals who find themselves in a temporary and sudden financial problem.

 

Characteristics of Short Term Loans

Short term loans are termed as such because of how quickly it needs to be paid off. In most cases, it must be paid off within six months to a year and a half, and any loan that takes longer than that is already considered medium term or long term.

In fact, the longer termed loans can last from just over a year to 25 years. Sometimes, some short term loans don’t specify a payment scheme and just lets the borrower pay any amount every day until the loan amount is completely returned.

 

Types of Short Term Loans

Short term loans come in various forms, as listed below:

 

1. Merchant cash advances

Given its name, such a type of short term loan is actually a cash advance but still operates like a loan. As such, the lender loans the amount needed by the borrower and the payment is made by letting the former access the latter’s credit facility. Each time a purchase by a customer is made, a certain percentage of the payment is taken by the lender before the amount even reaches the account of the business.

 

2. Lines of credit

A line of credit is much like using a business credit card wherein a credit limit is set, and the business is able to tap into the card and repay whatever was borrowed in installments. One advantage of lines of credit over business credit cards is that the former gives access to lower Annual Percentage Rates (APRs).

 

3. Payday loans

They are emergency short term loans that are easier to take as even high street lenders offer them. The drawback is that the entire loan amount is returned in one lump sum once the borrower’s pay arrives. In fact, repayments are done by the lender taking out the amount from the borrower’s bank account by using the continuous payment authority.

 

4. Online or Installment loans

It is also a very easy-to-get short term loan wherein everything is done online – from application to approval. Within minutes from getting loan approval, the money is wired to the borrower’s bank account.

 

5. Invoice financing

It is a type of loan that is done by using a business’ invoices that are still unpaid by customers. The lender loans the money and charges interest based on the number of weeks the invoice remains outstanding. So, when the invoice finally gets paid, the lender will interrupt the payment of the invoice and take the interest charged on the loan before returning to the borrower what is due to the business.

 

Advantages of Short Term Loans

There are many advantages in taking short term loans, including:

 

1. Shorter time for incurring interest

As short term loans need to be paid off in about a year, there is a lesser chance for incurring interests. Compared to long term loans that take many years to mature, interest on short term loans can only be charged for 12 months or so.

 

2. Quick funding time

Short term loans are less risky compared to long term loans because of a shorter maturity date. As such, the time it takes for a lender underwriting to process the loan is shorter, and the process is less thorough.

 

3. Easier to acquire

Short term loans are the lifesavers of smaller businesses or individuals who suffer from bad credit scores. The requirements are less, making them easier to fulfill.

 

Disadvantage of Short Term Loans

The main disadvantage of short term loans is that they provide smaller loan amounts only. As the loans are returned or paid off sooner, they usually involve small amounts so that the borrower won’t be burdened with large monthly payments.

 

Key Takeaways

Short term loans are very useful for businesses and individuals. For businesses, it is a good way to resolve sudden cash flow issues i.e., some invoices are still outstanding, or a customer is unable to make a monthly payment. For individuals, such loans are an effective source of emergency funds.

 

More Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

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  • Effective Annual Interest Rate
  • FICO Score
  • Revolver Debt

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