The Merchant’s Guide to Short-Term Loans

Short-term 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. These loans are useful for a lot of merchants, but also have some characteristics which might make them unsuited to particular businesses.

Is your business a good candidate for a short-term loan? In this article, we’ll cover everything you need to know to make an informed decision, from how short-term 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 loans!

Short-Term Loan Basics

Short-term loans function a little differently than traditional loans. Instead of having an interest rate, short-term loans have something called a factor rate. Because of the difference in fee calculations, short-term loans cannot be compared to loans that charge interest in an apples-to-apples way.

The fee for a short-term loan, called a fixed fee, is calculated using the factor rate. 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).

For more information on factor rates, check out our article on the subject. 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.

As you might expect given the name, short-term loans generally have short term lengths. In the past, borrowers would have difficulty finding a loan with term lengths over 18 months; however, many lenders are starting to offer short-term loans with term lengths of up to two or three years in length.

Short-term loans generally aren’t repaid on a monthly basis, though. 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.

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.

Short-Term Loan Eligibility

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.

Otherwise, short-term lenders tend to have qualifications that are easier to meet than those of lenders that offer other loan products. You may be eligible for a short-term loan, even if you are not eligible for a loan from a bank, credit union, or some alternative lenders. If you have a credit score of at least 500, a business that is over 3 months old, and have healthy, consistent cash flow, you are probably eligible for a short-term loan. Naturally, however, the stronger your business, the better rates and fees you’ll be eligible for.

Short-Term Loan Uses

Short-term loans have many uses, but they are not suited for all business situations. As you might expect, these loans are generally best used for short-term financial needs, such as:

• Working capital
• Inventory purchasing
• Hiring and training
• Equipment purchasing
• Business expansion
• Marketing

As long as you’re using the money for business purposes, most short-term lenders don’t have strict requirements regarding the specific use of your funds. The above are common uses for a short-term loan, but you might find other uses.

Pros and Cons

Short-term loans have a lot of perks, however, there are some drawbacks you’ll want to consider before accepting an offer.

Short-Term Loan Pros

There are many reasons a business would want to take out a short-term loan:

• Low Borrower Qualifications: As long as you have a consistent cash flow, you have a high likelihood of qualifying for this loan product.
• Fast Application & Funding Process: 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.
• No Loan Use Requirements: As long as you’re using the money for business purposes, most lenders don’t care how you specifically use the funds.
• No 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).

Short-Term Loan Cons

Nonetheless, short-term loans tend to have a few drawbacks:

• Expensive Fees: With fees that usually range from 9% to 60% of the money you’re borrowing, short-term loans can be very expensive.
• Fast Repayment: Not only can short-term loans come with hefty price tags, you have to repay the borrowing amount and fee relatively quickly.
• 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.

A Note On 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. 

Head over to our article on double dipping for more information on this practice.

Evaluating Your Short-Term Loan Offer

Short-term loan offers have to be evaluated a little differently than other types of loans because the fee for borrowing is calculated by a factor rate instead of an interest rate.

Below is a summary of the factors you’ll want to keep in mind when evaluating and comparing loan offers. For a more thorough explanation, check out our article on the subject.

• The Total Repayment: The amount of money you’ll have to repay in total.
• The Cents On The Dollar Cost: The amount you’ll have to pay in fees per dollar borrowed.
• The Effective Annual Percentage Rate (APR): The estimated APR. Although it’s not technically possible to calculate the APR on a short-term loan, you can get a rough estimate for comparison’s sake. For more information, read our article on short-term funding and APRs.
• The Monthly Payment: About how much you’ll have to repay per month.
• Prepayment Penalties Or Discounts: Whether or not the provider gives you a discount for repaying early, or participates in double dipping.

Short-Term Loan Calculator

If your loan provider doesn’t share all the above information with you, a calculator, such as the one below, can be used to estimate your periodic payments, the effective APR, the total repayment amount, the cents on the dollar, and other important information that will help you make an informed borrowing decision.

Head over to the Short-Term Loan Calculator page for more information on this calculator, including a thorough explanation of all the inputs and outputs.

Final Thoughts

Short-term loans are an excellent resource for many businesses. Even if you don’t qualify for other types of business loans, most businesses with a strong cash flow will qualify for this type of loan. Additionally, they’re faster and easier to obtain than loans from other sources.

On the other hand, financing products of this sort can be more expensive and have a more demanding repayment than other loans; businesses will want to weigh the pros and cons carefully before accepting an offer.

Interested in pursuing a short-term loan? Your next stop is our short-term finance comparison chart or our full list of short-term finance reviews. Or, for more information related to short-term loans, check out these articles:

• What Is A Merchant Cash Advance?: Information on merchant cash advances, a product very similar to short-term loans.
• The Dangers Of Stacking Small Business Loans: Why you shouldn’t take out multiple short-term finance products at the same time.
• Merchant Cash Advances & APRs: How to calculate APRs on short-term finance products, including short-term loans.
• Double Dipping: The Hidden Cost Of A Merchant Cash Advance: Learn about the practice of double dipping, or paying interest on interest.