What Is A Short-Term Business Loan & When Is It Right For My Small Business?
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? In this article, we’ll cover 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 Is A Short-Term Loan?
Short-term business loans are a relatively recent addition to a merchant’s arsenal of business loan options. Introduced in the last decade or so, short-term loans are similar to traditional installment loans, but fees are calculated a little differently.
First, the obvious part. 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 something called a flat fee, or sometimes a factor rate. 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 are borrowing $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 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 on a monthly basis. 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 automated clearing house (ACH).
Unlike merchant cash advances, which have 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 have a high likelihood of qualifying 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 will require a personal guarantee and a blanket lien but don’t require specific collateral (like 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. For more information on prepayment penalties check out our article on factor rates.
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 12 Different Types Of Small Business Loans You Should Know feature.
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 x1.40 (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 end up paying your loan off 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. If you’d like to read more, head over to our article Double Dipping: The Hidden Cost Of A Merchant Cash Advance for more information on this practice.
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 not really a niche product anymore, 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 like 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.
5 Tips For Applying For Short-Term Business Financing
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.
Check Your Cash Flow
Short-term loans are sometimes called “cash flow loans” for a reason — 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.
Have The Right Documentation
Your application will go faster and more smoothly if you have the necessary information handy in advance. This includes things like personal identification, 3-6 months of bank records, and corroborating documents to show that you are, in fact, the owner of your business.
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.
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 3 years, you can qualify for a short-term loan within a few months. That said, you still have to show you can keep the lights on for at least a little while.
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.