When You Should (and Shouldn’t) Apply for a Short-Term Loan
Short-term loans are a great option for some business owners, while they make less sense for others. Below we’ll take a look at when you should, or shouldn’t, consider a short-term loan.
PHOTO CREDIT: Getty Images
There are a lot of loan products available on the market today, but short-term loans are one option that's gaining popularity among small business owners. Short-term loans are designed as cash flow infusions to meet immediate financing needs. They can be a flexible financial tool to better manage cash flow, deal with unexpected needs for extra cash, or take advantage of an unforeseen business opportunity.
Short-term loans are a great option for some business owners, while they make less sense for others. Below we'll take a look at when you should or shouldn't consider a short-term loan.
Should: If You're a Seasonal Business Owner
Seasonal businesses experience periods of great fluctuation in terms of income, but those changes are highly predictable. If you've been running your ice cream store or ski rental shop for a few years, you can likely forecast your earnings during your busy season with great accuracy.
If you need access to funds to prepare for the busy season and feel confident you'll be able to make repayments once things pick up, a short-term loan may be a great option for you.
Should: If You're a High-Volume, Small-Dollar Sales Business
While small-dollar sales may mean that you don't always have massive cash reserves on hand for larger purchases, the high-volume nature of your business means that you'll be able to keep pace with the daily repayment structure of a short-term loan. This might be the perfect option to help you purchase an unexpected big-ticket item or take advantage of an unforeseen business opportunity.
Should: If You Have Less-Than-Stellar Credit
While traditional bank loans and even some other forms of alternative lending require a strong credit score, short-term loans can be an option for those with a credit score as low as 550. Because short-term loans are typically repaid within three to 18 months, lenders foresee less of a risk of default and are more likely to take on borrowers they see as riskier.
Should: If You Have an Earnings History
Because short-term loans are issued based on projected future cash flow, your business needs to have an earnings history to qualify for this type of loan. Lenders will consider your previous year's earnings to estimate what your revenue will be this year. If this is your first year in business, lenders will be hesitant to take you on as a borrower because there's no way for you to prove you'll have income on hand to pay back the loan.
Shouldn't: If You're Not Ready to Make Repayments Yourself
While short-term loans don't require you to offer up collateral to back the loan, the lender may ask you to make a personal guarantee before approving you. This means that you must agree to personally repay the loan if your company defaults on its payments. This, of course, puts your personal finances on the line, so make sure you're comfortable with this arrangement before signing on.
Shouldn't: If You Can't Handle Higher Interest and Fees
Typically, lenders will charge a higher interest rate for short-term business loans. The interest rates on short-term loans typically start around 15 percent, with the shortest loans generating the highest interest rates.
Lenders can also charge a variety of fees, including origination fees, late fees, service fees, prepayment penalties, and fees for insufficient funds. Read through the paperwork on the loan carefully to ensure that you aren't surprised later on by the total cost of the loan.
Shouldn't: If You Don't Have a Cash Cushion
While the daily repayments may seem hassle-free, they can leave you in trouble financially if you don't have sufficient funds in your business bank account to cover the repayments. You'll need a cash cushion to guarantee that you don't find yourself short on funds, as penalties and fees associated with a delay in payment can quickly add up and leave you in worse shape than before you applied for the loan.
Shouldn't: If You Can't Count on Your Customers
Because short-term loans are dependent on your future cash flow, you need to be confident in your ability to meet your cash flow projections before pursuing this type of financing. If you've had problems with non-paying or late-paying customers in the past, this might not be the best loan option for you.
Short-term loans are a great fit for those business owners who find themselves needing a cash infusion to tackle an unexpected issue or seize a surprise business opportunity. But if this loan type doesn't make sense for you, there are many other financing options out there-one of which will be the perfect fit for your business's needs.