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The Pros and Cons of High-Cost, Short-Term Lending

By Jessica Elliott Reviewed By Mike Lucas
By Jessica Elliott
By Jessica Elliott Reviewed By Mike Lucas

If you’re in a cash crunch and need funds quickly, what are your options?

Conventional or government-backed loans can take time to process. It may be weeks before you receive the money.

Short-term business lending offers a convenient application process and quick access to funds. Learn how these loans, including high-cost short-term credit, can help your situation.

What Is Short-Term Business Lending?

Short-term business lending is the process of receiving a working capital loan from a lender that you pay off within a short timeframe. Business loan terms may give you up to 18-months to repay your funds.

As with conventional loans, you’ll pay back your loan amount plus interest and other fees. Short-term financing differs from standard loans because it requires less paperwork or documentation.

This convenience comes with a price, usually in the form of higher annualized interest rates. For instance, high-cost short-term loans may offer reasonable rates if you pay within months.

If you take a year to pay, these interest rates may equal a 300% to 500% annual percentage rate (APR). Compared with the APRs of personal loans or credit cards, which range from 10% to 30%, high-cost short-term credit costs you more.

Furthermore, some lenders may charge early repayment penalties, meaning you get charged a fee if you pay off your loan early.

Fortunately, you can find short-term lending options with fair interest rates. These loans can give you fast access to cash so you can keep your business doors open.

You can find short-term lending options with fair interest rates.

Examples of Short-Term Commercial Lending

There are several types of short-term lending solutions. Each offers different financing terms and may work better for specific situations.

Before applying for a business loan, consider your options. Look for financing terms that fit your circumstances and offer reasonable rates.

Accounts Receivable Financing

Accounts receivable financing also is called invoice financing or invoice factoring. With this financing, you get a percentage of what you’re owed on outstanding invoices from your lender.

Once your customer pays, your lender takes out fees, and you receive the rest of the funds. These loans provide:

  • No limits on what you use the money for
  • Same-day access to funds
  • Up to 80% of your outstanding invoices
  • Term lengths dependent upon when your customer pays the invoice
  • Factor rates instead of an APR

Merchant Cash Advance

With a merchant cash advance (MCA), you get an advance on your future sales. Business owners usually pay daily or weekly payments until the advance and fees are paid in full. MCAs offer:

  • Payment terms of 3 to 24 months
  • Up to $500,000 in financing
  • Factor rates instead of an APR
  • Loan funds within 24 hours

Business Lines of Credit

A business line of credit is a flexible solution for ongoing cash flow concerns. You only pay interest on funds you use. Once you pay back the borrowed amount, then the full funds are available for use. A business line of credit:

  • Doesn’t incur interest until you use the funds
  • Offers 6 to 24-month repayment terms
  • Puts funds in your bank account within 24 hours
  • Requires a credit score of 560 or higher

Do you need a loan for your small business?

Working Capital Loans

Cover operating or project-based expenses with a business capital loan. Working capital loans include cash advances, short-term loans and lines of credit. A working capital loan requires:

  • Daily or weekly loan payments
  • Repayment timelines of 3 months to 5 years
  • A minimum credit score of 550

Short-Term Business Loans

Use a short-term loan to cover emergency expenses or income shortfalls. These loans require daily or weekly payments. Repayment term periods typically are 3 to 18 months. Short-term business lending options help you:

  • Finance up to $500,000
  • Upgrade equipment or pay employees
  • Stay afloat during a slow season

Equipment Financing

Replace equipment for your business with a loan dedicated to that purpose. An equipment manufacturer may offer equipment financing, or you can use a third-party lender. These loans offer:

When Do Small Businesses Use Short-Term Loans?

Most short-term business loans help a small company pay their bills — from operating expenses to payroll — during a financial shortfall. A company may choose a short-term loan to avoid paying interest payments over many years, which increases lending costs.

Situations in which small businesses may use a short-term loan include:

  • A need to stock inventory for a seasonal business
  • Startup expenses for a new project
  • Taking advantage of a business opportunity
  • Short-term financing for emergency repairs
  • Seasonal cash-flow issues
  • Emergency equipment replacement

When it comes to short-term loans, it’s crucial to weigh the pros and cons.

Pros of Short-Term Lending Options

There are several advantages to receiving a short-term loan.

Of course, the biggest pro is that it fixes your pressing problem, from paying employees to covering expensive repairs. However, for small businesses, there are other benefits to short-term lending solutions, including:

Transparent Payment Terms

Before accepting a loan, you’ll receive short-term lending rates applicable to your situation and funding type. You also get a simple payment schedule. Your financial provider may offer daily, weekly or monthly payment options.

Fast Funding Options

Unlike long-term business loans, you can receive short-term funding within 24 to 48 hours. Same-day business loans help you pay your supplier for crucial inventory or get equipment repaired so you can reopen your doors quickly.

Easier and Shorter Application Process

Short-term lending applications usually take place online. Depending on the loan type, you may not need extensive documentation required for long-term financing options.

Instead, you share pertinent details on your digital application and may be prompted to connect your accounting software or bank account for quicker loan determination.

Flexible Requirements

To get a regular loan, you may face more restrictions. For example, many lenders require good to excellent credit scores, a certain number of years in business and a minimum revenue figure.

However, short-term lending solutions may work for business owners with lower credit scores or even bad credit. You can work with short-term lenders to find a loan that doesn’t require collateral or provides funds based on incoming revenue instead of how much money you have in the bank.

It Can Raise Your Credit Score

When you take out a short-term loan and pay it off quickly, your credit score may go up. This is true with any financing, as regular and timely payments improve your credit score.

Since you pay off short-term loans quicker, you can see your score rise within months.

Cons of Short-Term Lending Solutions

When you’re in a challenging situation, you may overlook some of the negative aspects of short-term lending. Before selecting a short-term loan, it’s vital to ensure you can meet repayment stipulations.

A failure to do so may result in steep fines and larger payments that are difficult to pay off fully.

Frequent Loan Payments

Instead of monthly loan payments, a short-term loan requires daily or weekly payments. Although automating payments helps you save time, you need to have the funds in your account for recurring payments.

Higher Interest Rates

Short-term financing comes with higher rates. If you pay them off quickly, you can save money. But if you take a full year or more to pay off, then the interest rate could be higher than getting a cash advance from a credit card.

Possible Early Repayment Penalties

Some lenders charge you extra fees if you pay your loan off early. This can drag out your loan terms, forcing you to pay more over a more extended period.

If a lender charges early repayment penalties, then look for other options as plenty of financing companies don’t charge these fees.

Business Risks

The increased financial pressure from high-cost short-term credit poses a risk for business owners. You must prioritize paying off a short-term loan and put other projects on the back burner.

If you can’t recoup your money quickly, you may feel inclined to take out another loan or extend your loan terms. Doing so can put you in a position where your cost of debt is more than your revenue.

No Payment Flexibility

Once you agree to the loan terms, there’s little flexibility to make changes. For instance, you can’t defer or skip a payment.

If you miss a payment, the penalties may be severe, resulting in increased interest rates and late charges. The cost of extra fees and interest on top of an already high loan amount can spiral into insurmountable debt.

May Require Connecting Your Accounts

Many short-term lending solutions use your accounting program or online banking information during the application and repayment process.

Although doing so helps you get approved and paid quicker, not everyone wants their accounts connected to a lender.

Is Short-Term Business Lending Right for You?

Weigh the pros and cons of short-term business lending options and offerings from various providers.

The best business financing solutions provide the funds you need with affordable interest rates.

Jessica Elliott Contributing Writer at Fast Capital 360
Jessica is a business-to-business content strategist and consultant with 24 years of experience in the restaurant and hospitality industry. She writes about technology, marketing and finance.
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