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The Pros and Cons of Short-Term Business Loans
November 18, 2020
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The Pros and Cons of Short-Term Business Loans

One of the most important components of running a business is finding ways to effectively allocate capital. With a sound financial plan, your business can minimize operational costs and maximize potential growth.

If your business is unable to get approved for additional capital from a bank, you may want to consider applying for a short-term business loan. Alternative lenders and the Small Business Administration (SBA) both offer this financing option.

Every small business owner is different, so business financing will never be “one size fits all.” A type of financing that might be beneficial to another business might not be the right option for your company. Due to this, we’ll explain the pros and the cons of applying for a short-term small business loan, so that you can determine if this type of loan makes sense for your company.

What Are the Pros and Cons of Applying for Short-Term Business Loans?

Pro: You Should Receive Your Loan Quickly

The most obvious benefit of a short-term business loan is that it can provide you with fast capital for your operations. In addition, a short-term business loan application is typically shorter than that of a traditional bank loan and requires less information. This can be incredibly useful if your business has bills that are due soon, and can’t afford to wait on a long approval process.

Con: These Loans Come with High Interest Rates

Since the application process is much more lenient than alternatives, most short-term business loans have comparatively high interest rates. When compared to loans that are more exclusive or have longer terms, you’ll usually end up paying significantly more in exchange for the same loan amount.

The best way to minimize the total cost of securing working capital l is to repay it as quickly as possible. This can be especially crucial if your financial institution provides an early repayment discount.

Pro: The Loan Application Process is Simple

As we previously mentioned, the application process for short-term financing is fast. In addition, it will likely be easy to complete. These loans require relatively little paperwork and the applications can usually be completed online. If you have any questions, be sure to contact the lender you’re applying with.

Con: Frequent Payments Are Required

A notable drawback of applying for a short-term business loan is the fact that most of these loans require very frequent payments. In fact, many of these loans require weekly, or even daily, payments. If your business doesn’t have consistent revenue source, you should consider other loan options that might offer more flexible repayment terms.

However, if you’re unable to make these payments, you may qualify for trade credit. With this option, you can buy items on credit and pay the supplier at a later date. It’s still considered short-term financing, but functions differently than a traditional short-term loan from a lender.

Pro: Easy to Qualify for

When compared to more traditional business financing options, most short-term business loans have remarkably high approval ratings. Even if your small business has limited or poor credit history, you still could qualify for a short-term loan. The lender will still want to review both your personal credit and business credit scores, but their requirements probably won’t be as stringent if your score is good.

If you have poor credit, you may need to apply for a secured loan instead. To ensure you repay the loan, the lender will ask you to submit collateral. If you’re unable to pay off your loan, they’ll collect the collateral in exchange.

Although this will help you receive financing, it’s important to consider what will happen if you lose the collateral. For instance, losing business equipment could make it difficult for you to run your operations.

Con: There’s the Potential for Significant Debt

It is important to note that regardless of your financing product (whether it be a loan, business line of credit, or credit cards, to name a few examples), acquiring any sort of business debt is inherently risky.

Generally, you should only apply for a loan if you believe you can repay your debt in full and on time. Otherwise, your business risks getting caught in a “cycle” of debt payments. This could be hard on your bank account and ultimately jeopardize your business’s future.

Is a Short-Term Business Loan Right for Me?

Short-term loans can be a beneficial way to finance your business, but that doesn’t mean these loans don’t have drawbacks.

Before submitting a loan application, your business should consider all available options. If you can qualify for a lower-interest loan, and your need for capital isn’t time-sensitive, then a short-term loan may not be the most suitable option.

In addition, if even after securing capital your business will continue to experience cash flow gaps, you shouldn’t count on a short-term loan to completely resolve your current financial problems.

However, despite these risks, short-term loans can be helpful to your business. If your business has relatively quick cash flow cycles, a reliable method for repaying your debts, and will benefit from an immediate capital infusion, then a short-term business loan might be right for you. Whether it makes sense to apply for this loan type will depend on the specific conditions and characteristics of your business.

Has your small business received a short-term business loan? Tell us about your experience pursuing and receiving this loan option in the comment section below!

Editor’s Note: This post was updated for accuracy and comprehensiveness in November 2020.

Fora Financial

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

Andrew Paniello
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Andrew is an experienced writer with a degree in Finance from the University of Colorado. His primary interests are investing, entrepreneurship, and economics.