What Is A Short-Term Business Loan & Does My Business Need One?

Short-term loans can be highly beneficial for small businesses, but they don't come cheap. Our tips will help you make an informed decision.

WRITTEN & RESEARCHED BY
Kymberlin Bush
Expert Contributor

Last updated onUpdated August 19, 2024

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Key Takeaways

Short-term business loans are ideal if you need money fast, with funding available from some lenders in as little as 24 hours.
These loans are great if you have poor credit or don't want strict loan use requirements, but they come with higher rates and potential prepayment penalties.
To qualify, your business needs consistent cash flow, and you should be prepared for frequent repayments (typically daily or weekly).

For many small business owners, short-term business loans can be a fast and easy way to access extra capital.

New to business loans and need quick funding? In this post, we’ll discuss short-term loans, whether your business is a good candidate, and how to find the best short-term loans for small businesses.

Table of Contents

What Is A Short-Term Business Loan?
Is A Short-Term Loan Right For Your Business?
Potential Short-Term Business Loan Risks
How To Qualify For Short-Term Business Loans
Where Can You Get Short-Term Financing?
Alternatives To Short-Term Loans

What Is A Short-Term Business Loan?

Short-term business loans are similar to traditional installment loans in that you can receive a lump sum of cash from a lender. However, there are several key differences.

Term Lengths Of Short-Term Business Loans

As the name suggests, short-term business loans generally have shorter term lengths than other installment loans. Many long-term loans are repaid within one year, with some lenders offering terms up to two years.

Interest Rates Of Short-Term Business Loans

Short-term business loans do not have interest rates like traditional installment loans. Instead, short-term loans have flat fees (also known as factor rates), which are presented as a percentage or multiplier.

Unlike interest, this fee is only calculated once so you’ll know exactly how much you’ll be repaying before you accept a loan offer. Factor rates can range anywhere from 1.09-1.6 (or 9%-60%) of the borrowing amount.

For example, you borrow $10,000 and your factor rate/flat fee is 1.35. You will have a fixed fee of $3,500 for a repayment total of $13,500. This fee could also be expressed to you as 35%.

Additional Fees

Some lenders may require other small business loan fees in addition to the factor rate, like origination or closing fees.

Repayment Terms Of Short-Term Business Loans

Short-term loans generally aren’t repaid every month; most lenders require repayment every business day or every week. These payments are typically automatically deducted from your business checking account by an ACH payment and are fixed unlike a merchant cash advance.

There are exceptions to just about every rule, so keep an eye out for lenders like Square Capital that have fluctuating payments.

Is A Short-Term Loan Right For Your Business?

Short-term business loans can be useful for many small business owners, but they do have some characteristics that might make them unsuited to particular businesses.

When A Short-Term Business Loan Is The Right Choice

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 A Short-Term Business Loan Is The Wrong Choice

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.

Potential Short-Term Business Loan Risks

While short-term business loans are quick and easy, there are some risks to keep in mind. Here are the potential pitfalls of short-term loans.

Expensive Rates

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 reaches 1.20 or 20%. Steer clear of a 1.40 (40%) unless it’s an emergency.

Prepayment Penalties

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 money 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.

Fixed Payments

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.

Double Dipping

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.

How To Qualify For Short-Term Business Loans

Lenders tend to differ on the exact qualifications they’re looking for, but there are some general things you can do to maximize the chances of your short-term business loan application being approved.

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.

Don’t have a business bank account yet? We can help! Check out our article on how to open a business bank account.

3 Months Of Bank Statements

It’s not unusual for your lender to ask for a certain 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.

Have The Correct 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.

Check Your Credit Scores

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 responses 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.

Time In Business Of 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.

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 Can You 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.

Online Lenders: Many online lenders offer short-term loans with an eye toward businesses with sub-optimal credit. Do your due diligence, however, because some online lenders can be sketchy at best and dishonest at worst. We’ve done some work for you already, feel free to start your research with our article about some of our favorite lenders.
Traditional Banks: Brick-and-mortar banks are generally known more for mortgage, car, and commercial loans than short-term loans. Some banks have begun offering their own versions of short-term loans to compete with online lenders. Short-term business loans from a bank are going to have better rates than online lenders, but their applications are going to be much more involved, and their standards for lending are much higher.
Merchant Services/Payment Platforms: Card processors like PayPal, Square, and Stripe all offer their customers short-term loans. They’re different than typical short-term loans because they don’t usually have definitive term lengths or fixed payments. Instead, your payment processor will collect a percentage of your daily sales and pass that through their system until your loan has been paid off. This is very similar to a merchant cash advance, and there’s a lot of overlap between the two, but these services are still classified as loans, not advances.

Alternatives To Short-Term Loans

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, explore small business loan types, or browse our picks for the best same-day business loans and merchant cash advances. If traditional loan methods don’t quite work for you, you can always explore options like microloans or crowdfunding.

No matter which option you choose, make sure to do your research, compare your options, and find the best loan for your situation.