Short-term loans are an excellent option for small businesses and individuals to meet their immediate cash needs. However, they are not always the right choice. Find out when to apply for short-term loans and when to stay away from them.
There are plenty of loan products available on the market today. Thanks to digital lending, borrowers can choose from several lenders – traditional banks, NBFCs, online lending portals, P2P lenders, and more. Due to the increase in competition, lenders today offer multiple loan products to attract borrowers.
These new-age lending products make it easy for borrowers – especially small business owners – to secure the right funding. They no longer have to jump through the stringent loan eligibility requirements placed by traditional lenders.
One popular loan product that has gained popularity in recent years is – short-term loans. As the name implies, short-term loans are offered for a shorter tenure compared to traditional term loans. They come with lower eligibility barriers, quick processing time, making them a popular choice among borrowers. Thanks to short-term financing, it’s easier than ever before for businesses to raise the funding they require and capitalise on growth opportunities.
Short-term loans help businesses and individuals better manage their cash flow and deal with emergency cash needs. With that said, just like every other loan product, short-term loans have pros and cons. It may not work for all at all times.
In this guide, we help you evaluate the pros and cons of short-term loans and help you decide whether you should – or should not – apply for short-term financing.
When to apply for short-term loans?
#1: If you have a less-than-excellent Credit Score
Generally speaking, traditional lenders do not offer term loans to borrowers with low credit scores. Since short-term loans are repaid within a shorter tenure – typically 3 months to 18 months, lenders do not consider them as risky as long-term loans. If you have a low credit score, then applying for a short-term loan is your best bet to meet your capital needs.
#2: You have a Good Track Record of Healthy Turnover and Profits
Lenders offer short-term loans based on the earnings history and projected future cash flow of a business. So, to be eligible for a short-term loan at an attractive interest rate, you will have to provide the lender with your profit-and-loss statements and turnover records for the past few years.
So, if you’re just starting out, then lenders may be hesitant to offer you a short-term loan. Even if they grant your loan request, you may not be able to snag the best interest rates. On the other hand, if you have an established business history, you will have higher chances of securing short-term loans at fair interest rates.
#3: If you run a Seasonal Business
Unlike regular businesses that experience a steady cash flow throughout the year, seasonal companies experience periods of fluctuation in cash flow. However, these changes are predictable. As a seasonal business owner, you can predict your high revenue months and low revenue months with accuracy. Some examples of seasonal businesses include tourist agencies, firecracker manufacturing, winter clothes stores, etc.
Seasonal businesses often require funds to invest in inventory, hire temporary staff, and upgrade infrastructure before the peak season. Short-term loans are an excellent tool to help seasonal business owners meet the cash flow needs before the peak season. You can then repay the loan once sales pick up.
#4: If you run a Retail Business
One of the biggest problems facing retail business owners is that they often do not have massive cash reserves in hand to pay for an extensive inventory. However, the high-volume nature of the business makes it easy for them to repay short-term loans comfortably.
If you’re a retail business owner, then taking short-term loans can help you capitalise on an unforeseen business opportunity and improve your cash flow.
When NOT to apply for a short-term loan?
#1: If you already have other ongoing loans and cannot handle the Frequent Repayments
Unlike long-term loans where you repay monthly, short-term loans usually have more frequent repayments – bi-monthly, weekly, or even daily. These regular repayments can become challenging, especially when you have other ongoing debts.
#2: If you cannot count on a Steady Cash Flow
Repaying the short-term loan can become challenging, especially if you don’t have a steady cash flow in your business. If you have trouble getting your customers to pay their bills on time, or if you experience a slow week, then it becomes difficult to repay the EMIs on time, exposing you to a danger of late penalties or even loan defaults.
#3: If you cannot handle the Higher Interest Rates
Though short-term loans are readily available, the biggest drawback is that they come with steep interest rates. Besides the high-interest rates, lenders also charge other fees like processing fees, prepayment penalties, and more. So, make sure to go through the terms and conditions of the loan carefully to ensure that you can manage the loan’s overall cost.
#4: If you do not have a Backup Fund to Pay in case of Emergencies
Whenever you take a loan, you need to ensure that you have a cash cushion – a backup fund – to repay the loan if you find yourself short on funds. This is especially true when it comes to short-term loans as the repayments are more frequent. Even missing a single payment can put your repayment schedule off track and bring down your credit score. You need to ensure that you have a backup fund to rely on in case of emergencies so that your loan payments are always on track.
Short-term loans are an excellent financial tool to help business owners tackle their cash flow problems and capitalise on business opportunities. However, it’s not always the right choice. It can be tricky and pull you into a debt trap when not handled correctly. If your business is susceptible to late invoice payments, fluctuations in sales, then you need to evaluate the repayment schedule before taking on a short-term loan.
Make sure to read the terms and conditions, weigh the pros and cons before taking a short-term loan so that you don’t get caught in a debt cycle.