When your business is in need of financing, there are many avenues you can explore. It can be tricky to know which type is best for your business.
While there are loan products out there that are tailored to meeting specific financing needs, such as equipment financing to assist in the purchase of new equipment and invoice financing to keep you afloat while you wait for invoices to be paid, long-term and short-term loans are great options to meet your more general financing needs.
Each type of loan has its own stipulations and pros and cons. By looking at the differences and similarities between these two common types of business loans, you’ll be able to make an informed decision about which works best for you and your business.
What’s a term loan?
Before we dive into the differences between short- and long-term loans, let’s go over what a term loan is more generally.
A term loan is when a lender approves you for a lump sum of cash that you pay back, plus interest and other fees, over time. This is a traditional type of business financing and probably what you’d imagine when you think of a business loan. The repayment term, or the amount of time you have to pay back the loan, is one of the major factors that distinguishes a short- vs. long-term loan.
What is a short-term business loan?
Short-term business loans operate much like the traditional term loan described earlier. You get a lump sum of cash that you pay off over time, plus interest and other fees. However, the repayment term for this type of financing is characteristically short.
Typically with a short-term loan, you pay back the loan, plus interest, over three to 18 months with daily or weekly payments. This differs from long-term loans where you generally pay the loan back over a number of years with monthly payments.
Due to the shorter repayment period, short-term loans also come with higher interest rates.
Why consider a short-term loan?
Short-term loans are ideal for dealing with the unexpected. Whether that’s a cash flow issue before your busy season, a surprise project that calls for additional supplies or equipment, or an uptick in demand for a product, short-term loans can cover it all. Unlike some other loan products, there usually aren’t restrictions on how you can use the funds.
Because the application process typically takes place all online, approval can happen quickly, in as little as one day. The shorter repayment term also means lenders are more willing to take a risk on a borrower who has weak credit, so even if your score is less-than-stellar you may still be eligible for this type of loan.
What is a long-term business loan?
Long-term business loans have terms of one to five years, and their interest rates are generally lower than those of short-term loans. Because the time period on the loan is years rather than months, the loan amounts are usually larger and repayment is on a monthly basis instead of daily or weekly. You can secure long-term loans online or through a bank.
Why consider a long-term loan?
Long-term business loans are often used to finance a specific, long-term project or strategic initiative for a company that is in a growth phase. And because these loans rarely have restrictions on how the money is used, they’re ideal for meeting a variety of business needs—whether it’s developing a new product, rolling out a marketing campaign, or opening a second store location.
Because of the longer term of the loan, this is a better fit for businesses that have been around for a while and have a strong financial history to point to. Lenders will typically look for borrowers that have been in business for three or more years (although technically you are only required to be in business for one year), with annual revenue in the six-figure range and a credit score of 600+.
Two loans are (sometimes) better than one
There are instances where it may be appropriate for you to use short- and long-term financing simultaneously. Many businesses often have a long-term loan or a business line of credit on hand to meet costs associated with maintaining business as usual and expected growth. Since these loans are paid back over several years, there should be solid plans in place for how the funds will be used over that time and how to stay on track with interest payments.
However, what happens if in the middle of the borrowing period on a long-term loan you come up against an unexpected cost—like the need to increase your orders with suppliers to meet surprise growth in demand for your star product? You might not want to derail your long-term spending and repayment plan to meet this cost. With the quick turnaround time on a short-term loan application, you can get access to new capital specifically for this unforeseen cost without upending your other financial plans.
Keep in mind that some business lenders’ agreements restrict a borrower from taking on additional forms of credit, or “stacking loans.” If you take on another loan without your current lender’s knowledge, that could result in defaulting on your current business loan, so it’s important to check with your current lender before pursuing an additional loan.
Have a plan for your loan
Regardless of whether you have a short- or long-term loan, it’s important that you have a plan for your financing. Know how you’re going to use the money, how you’re going to repay the interest, and how you’re going to generate enough income to make the investment in the loan worth your while.
Before signing on to any kind of business loan, it’s a good idea to turn to a loan calculator to help you understand the full cost of the loan so you can choose the product that’s the right fit for you.
SOURCE: ALL BUSINESS