What Are Short-Term Business Loans & When Is It Right For My Small Business?
Short-term loans can be highly beneficial for small businesses in certain scenarios, but they don't come cheap and can even be risky. Our tips will help you make an informed decision.
If you’ve been reading our site or maybe just browsing online lenders, you’ve probably seen the term “short-term business loan” pop up. Short-term business loans have some unique properties that distinguish them from other types of installment loans.
Is your business a good candidate for a short-term business loan? This article covers everything you need to know to make an informed decision, from how short-term business loans work to which businesses are eligible to what you’ll need to look for in a good loan provider.
Read on for a crash course in short-term business loans!
Table of Contents
- What Are Short-Term Loans?
- Is A Short-Term Loan Right For Your Business?
- Potential Short-Term Business Loan Risks
- Qualifications For Short-Term Business Loans
- Where You Can Get Short-Term Financing
- FAQs About Short-Term Business Loans
- Final Thoughts: Choosing The Right Short-Term Loans For Your Small Business
What Are Short-Term Loans?
Short-term business loans are a relatively recent addition to a merchant’s arsenal of business loan options. Introduced in the last decade, short-term loans are similar to traditional installment loans, but fees are calculated differently.
First, short-term business loans generally have shorter term lengths than other installment loans. Short-term businesses rarely last over 18 months, with many lasting less than a year.
Short-term business loans also function a little differently than traditional installment loans. Instead of having an interest rate, short-term loans have flat fees (sometimes referred to as factor rates). It may be represented as either a percentage (18%) or a multiplier (x1.18). Like interest, the fee is a percentage of your borrowing amount. Unlike interest, the fee on a short-term loan is only calculated once. You will know exactly how much you’ll need to repay before accepting a loan offer.
For example, if you borrow $10,000 and your factor rate is 1.35, you will have a fixed fee of $3,500 (for a total repayment of $13,500).
Typically, factor rates range anywhere from 1.09-1.6 (or 9%-60%) of the borrowing amount, but in rare cases might be higher or lower. And naturally, lenders might require other small business loan fees in addition to the fixed fee, such as origination or closing fees.
Another difference comes in the form of repayments. Short-term loans generally aren’t repaid every month. Instead, most lenders require repayment every business day or every week. In the example above, assuming the loan was for 18 months, the borrower would have to pay about $35 per business day or $173 per week. Payments are usually automatically deducted from your business checking account by an ACH payment (ACH stands for automated clearing house).
Unlike a merchant cash advance, which has a similar fee structure, short-term loan payments are fixed. In other words, borrowers have to repay the same amount each day; the repayment amount does not fluctuate with cash flow. That said, there are exceptions to this rule: some lenders, such as Square Capital, do carry fluctuating payments.
Is A Short-Term Loan Right For Your Business?
Short-term business loans are useful for a lot of merchants but also have some characteristics that might make them unsuited to particular businesses.
When A Short-Term Business Loan Is The Right Choice
Here are some scenarios in which you may want to take out a short-term business loan:
- You Have Poor Credit: As long as you have consistent cash flow, you will likely qualify for a short-term loan.
- You Need Money Fast: Short-term loan lenders typically only require a few documents and make fast lending decisions. It’s not unusual to be approved for a loan within 24 hours and receive your funds a day or two later.
- You Don’t Want To Deal With Loan Use Requirements: In most cases, as long as you’re using the money for business purposes, most lenders don’t care how you specifically use the funds.
- You Don’t Have Specific Collateral: Most short-term lenders require a personal guarantee and a blanket lien but don’t require specific collateral (such as equipment or real estate).
When You Should Look For Another Type Of Business Financing
Short-term loans aren’t for every business. You may want to consider other options if any of the following are true:
- You Can’t Afford The Rates: Short-term loan rates tend to be higher, overall, than other kinds of installment loans.
- You Can’t Handle The Repayment Schedule: Daily, or even weekly payments, can be punishing if your business’s cash flow isn’t consistent.
- The Loan You’re Considering Has Prepayment Penalties: Because the fixed fee is pre-determined, you cannot save money by repaying your loan early. That said, some lenders offer discounts if you repay before your maturity date.
Short-Term Business Loan Alternatives
Short-term business loans are just one of many options for merchants who need a cash infusion. If short-term loans sound too risky, too fast, or too rigid for your business, you’ll want to find a type of financing that more closely fits your business’s circumstances.
For a detailed look at all your options, check out our article on small business loan types, or browse our picks for the best same-day business loans and merchant cash advances. Also, for some viable loan provider candidates, check out our reviews for OnDeck, Fundbox, Kabbage, SnapCap, BlueVine, and Fundera.
Potential Short-Term Business Loan Risks
So you’ve decided to get a short-term business loan. What should you be on the lookout for?
Paying Too Much
While you may be prepared to pay a premium for a short-term loan, that doesn’t mean you should accept just any rate. Be wary of any factor rate or flat fee that climbs out of the teens. And run away screaming from a 1.40 (40%) unless it’s a matter of life and death.
As we mentioned earlier, short-term loans frontload all of the interest that would, in other products, accumulate over time. This model works fine if you’re paying your loan off on the prescribed schedule. If you pay it off ahead of schedule, however, you’re paying for time you didn’t use.
You don’t want to be penalized if you finish paying off your loan early. Choose a short-term lender that offers discounts for early repayment.
Short-term loans usually have fixed daily or weekly payments that don’t fluctuate with your revenue. This can cause problems if you experience a sudden downturn in revenue.
Try to work with lenders who will work with you if your business encounters hard times before you repay.
Some short-term lenders employ a practice known as double dipping. This is a problem when a borrower renews or refinances a loan with a fixed fee.
Because the full fee technically has to be repaid even if the loan is paid early, borrowers who refinance or renew a loan are essentially paying interest on interest. If you choose a loan provider who participates in double dipping, you could be losing a lot more money than you would if you had chosen a provider who doesn’t use this practice.
If you think there’s a possibility that you’ll renew or refinance your loan down the line, it’s important to find a lender that does not participate in double dipping. For more information on this topic, head over to our article, Double Dipping: The Hidden Cost Of A Merchant Cash Advance.
Qualifications For Short-Term Business Loans
Finally, that brings us to the task of successfully applying for a short-term business loan. While every lender differs a little on the exact qualifications they’re looking for, there are some general things you can do to maximize your chances of being approved.
1) Check Your Cash Flow
Short-term loans are sometimes called “cash flow loans” because short-term lenders are typically more interested in your daily cash flow than in your credit score or your business profitability. As such, these loans are generally suited to businesses that have strong, consistent daily cash flow, such as retail stores, restaurants, and some service businesses. If your business has inconsistent or poor cash flow, chances are you are not a good candidate for a short-term loan.
Your Business Bank Account
Short-term loans will typically require a business bank account for both deposits and payments. As such, your lender will likely want to evaluate the inflows and outflows of cash into your account. Get a decent sense of the rhythms of your account before you apply.
3 Months Of Bank Statements
It’s not unusual for your lender to ask for X months’ worth of bank statements to evaluate your cash flow. This number will be three months in many cases, but be prepared to offer up to a year’s worth.
2) Have The Right Documentation
Your application will go faster and more smoothly if you have the necessary information handy in advance. This includes things such as personal identification, three to six months of bank records, and corroborating documents to show that you are, in fact, the owner of your business.
Your Business Tax ID Number
If you have an EIN, you’ll probably be able to speed up your application by making it easier for the lender to verify your identity. Note that many lenders will not explicitly require that borrowers have an EIN.
3) Have Decent Credit
You may be looking at short-term loans in part because you don’t have great credit, so you may be surprised to see this on this list. While your credit score matters less for short-term loans, you’ll still get better results and terms the higher your credit score is. So long as your credit score is over 500, you should qualify for something, however.
Your Personal Credit Score
Since many alternative loans require a personal guarantee, many will also check your personal credit score, typically through one of the three major credit bureaus.
Your Business Credit Profile
Though less common for short-term loans, some online lenders will check your business credit profile rather than or in addition to your personal credit. When it comes to your business, short-term lenders are usually more concerned with its cash flow.
4) Be In Business For At Least 3 Months
This is another area where short-term loans tend to be lenient. While many bank loans will want you to have been in business for over three years, you can qualify for a short-term loan within a few months.
Your Time In Business
Lenders want to see that you can keep the lights in your business for a least a few months before they extend you credit. Most short-term lenders are willing to work with businesses that have been around for six months. Some will work with businesses that only have been around for three months. Rare is the lender willing to make a business loan to a brand new business.
Your Annual Revenue
Servicing short-term loans can be expensive and disruptive, so lenders will want to see that your company takes in a minimum amount of revenue each year. Note that some lenders will look at average monthly revenue rather than annual.
5) Clear Any Outstanding Debts
Most lenders don’t want to be in line behind a lot of other lenders to collect on their debt should a borrower default. Not only that, but lenders will generally consider your debt-to-income ratio when evaluating your application. The lower the number, the less of a risk you’ll look like as a borrower.
Where You Can Get Short-Term Financing
Now that you have a sense of whether or not a short-term business loan is right for you, you’re probably wondering where you can get one. Short-term loans have been around long enough now that they’re no longer a niche product, so you have a few options.
Short-term loans are often associated with online lenders, and with good reason. Many online lenders offer short-term loans, often with an eye toward businesses with sub-optimal credit.
The quality of online lenders ranges from excellent to a smidge above organized crime, so make sure to do your due diligence before you sign anything you might regret. We’ve done a lot of the heavy lifting for you at Merchant Maverick, so feel free to start with some of our favorite lenders.
Banks are generally known more for mortgage, car, and commercial loans than short-term loans. That said, some banks have started to compete with online lenders by offering their own versions of short-term loans. For the most part, these seem to be small-value loans aimed more at individuals than businesses, but there may be exceptions.
Generally speaking, you can expect bank loans to have better rates than online lenders but more involved applications and higher lending standards.
Merchant Services/Payment Platforms
This one may come as a surprise, but card processing services such as PayPal, Square, and Stripe all offer their customers short-term loans. These loans are a little bit different than typical short-term business loans in that they generally don’t have definitive term lengths, nor do they have fixed payments. Instead, your payment processor will collect a percentage of your daily sales that pass through their system until you’ve paid off your loan.
If this sounds a bit like a merchant cash advance, you’re not off base. There’s a lot of overlap between short-term loans and merchant cash advances, but at the end of the day, these services are classified as loans, not advances.
FAQs About Short-Term Business Loans
Final Thoughts: Choosing The Right Short-Term Loans For Your Small Business
For the right borrower in the right circumstances, a short-term loan can be a fast and convenient way to borrow money. Borrowers with poor credit who have been locked out of the traditional lending market, in particular, may find short-term loans to be one of the better options on the table. Just remember to get quotes and compare rates to make sure you’re getting the best deal you can.