Searching for loans for your small business can be overwhelming with the amount of options available. The most common financing for small businesses that people turn to for help is term loans. A term loan, simply put, is a lump sum that a lender approves for a borrower’s business account.
There is more than one type of term loan: long-term loans and short-term loans. You may already be familiar with long-term loans for your personal mortgage; they are loans that have a long repayment period, such as 30 years. Conversely, short-term loans may only take a year or two.
Although the major difference between the two is obvious from their names, these term loans have less obvious differences, such as eligibility requirements, funding amounts, and interest rates. Understanding the differences and similarities between short-term and long-term loans is an important step in finding the right type of loan for your small business.
What are Long-Term Loans?
As their name implies, long-term loans are term loans that have repayment plans that are over the course of several years. Although there is no actual definition of what makes a long-term loan long-term, financial officials consider loans that have repayment plans between 60 to 84 months or 5 to 7 years long-term.
They are not capped at 7 years, of course; many personal loans exceed this standard, including student loans and mortgages that can be from 10 years to 30 years. Long-term business loans tend to stay between the 5 and 8-year repayment period.
Getting a long-term loan allows you to break down large amounts of debt into more manageable payments over time. Because of this, long-term loans are usually for large amounts of money, often to start businesses or buy expensive equipment.
When it comes to qualifying for a long-term loan, lenders are careful to make sure you are able to pay back the loan over the years. They require financial documentation from your business and personal finances. It’s important to have a good or excellent credit score when applying for long-term loans, as well as a business plan if you are just starting your business.
Types of long-term loans for small businesses
As you look for long-term loans for your small business, keep in mind there are multiple options to choose from. Each long-term loan will have advantages and disadvantages to them, as well as qualifications your business must meet.
SBA Loans – Small Business Administration loans are government backed loans that are specific for smaller businesses. They are excellent long-term loan options for business owners as they tend to offer lower interest rates and high funding amounts. With government backing, the loan is more secure than other types of loans. However, because of this, the requirements to obtain an SBA loan are more strict, and you will need to have a strong credit history.
Term Loans – Most long-term and short-term loans are term loans. They are a lump sum funding amount that is broken into a repayment plan. How long the repayment plan is, determines whether or not it is a long-term loan or a short-term loan. The requirements for a term loan will vary by the type of term loan it is and the lender who is offering it.
Commercial Real Estate Loans – Commercial real estate loans are a type of term loan that businesses use to fund their operations. This can be offices, warehouses, or income-producing properties. As they are meant to finance property or property renovations, commercial real estate loans are often one of the largest loans you can get, up to millions of dollars. Since they are large loans, they are some of the longest-term loans available.
What are Short-Term Loans?
In comparison to long-term loans, short-term loans are loans that are paid off in a short amount of time, usually between 6 months to 1 year, although there are some that can be as long as 18 months.
Short-term loans are intended for small amounts of money that can be paid back quickly. For example, many small businesses use them to buy inventory ahead of a busy time period like Christmas or as emergency money. Like long-term loans, lenders expect a good financial history for both you and the business, including the income to pay back the loan on time.
Types of short-term loans for small businesses
Although there are no specific short-term loans, there are loans that are better suited for short-term repayment plans due to their size. Short-term loans are available as SBA loans and term loans, just like long-term loans, but they will be for smaller amounts with a shorter repayment period.
Working Capital Loans – If you are in need of financing for everyday expenses, a working capital loan is a good option. This term loan can come in many different funding amounts, often smaller ones, that help you cover short-term operating needs. Like other term loans, be sure you have consistent revenue before applying for a working capital loan so you can pay back the loan on time.
Business Line of Credit – As a business owner, you may not know exactly how much money you will need, in which case a business line of credit is a good short-term option. Business lines of credit work like credit cards. You are able to use only the amount of cash you need from the credit line and pay back what you use, allowing you to avoid overpaying for financing.
Invoice Financing – Another type of line of credit, invoice financing allows companies to purchase products that they can sell at a later date. The products that are purchased are used as collateral for the loan. Invoice financing is often used in retail to purchase products for upcoming seasons; they can use the revenue to pay back the loan.
What are the Advantages and Disadvantages of Short-Term vs Long-Term Loans?
Both long-term and short-term loans have advantages and disadvantages to them. Which one you decide on will depend on what you are looking to finance and how much, among other factors.
Pros of long-term loans
Large financing amounts – Long-term loans are an excellent choice for small business owners who need a large amount of funding, such as millions of dollars. The long-term repayment period allows for higher amounts than short-term loans, which must be repaid back quickly.
Smaller monthly payments – Due to the higher funding amounts, most long-term loans have smaller monthly payments compared to short-term loans. A smaller payment can be helpful to businesses that need some extra cash flow to help run their business but don’t have the resources for an expensive monthly payment.
Fixed monthly payments – Monthly payments with long-term loans are also usually fixed amounts. This means you won’t have any surprises when it comes to your bills and you can plan ahead.
Cons of long-term loans
More interest – Due to the nature of the loan, you will end up paying more interest over time. For example, if you took out a $20,000 loan at a 10% interest rate, you would pay $11,716.18 in interest, whereas a short-term loan of the same amount and the same interest rate would only be $1,099.81.
A longer time in debt – A long-term loan means you will be in debt for longer than you would a short-term loan. That money may be beneficial, but you will have a monthly payment for many years unless you are able to pay it off early. If you are able to pay off the loan early, though, your lender could charge you a fee.
Higher interest rates – Lenders see long-term loans as risky investments. While they will have a stream of income for a while from the repayment, there is always a risk the business may not work out and go under. To compensate for this risk, interest rates tend to be higher on long-term loans, which means you will pay even more than expected when getting your loan.
Pros of short-term loans
Faster access to money – Unlike long-term loans, many lenders can process your short-term loan application quickly, and you are able to have access to the cash flow within a few business days. This is helpful for businesses that may need it for emergencies and can’t wait for a long approval process.
Easy to qualify for – Short-term loans are a good choice for businesses that may not have the best credit score, as the requirements are usually less restrictive. The lender may ask for collateral if you do have bad credit, though, so make sure you are willing to lose the collateral if you are unable to pay back your loan.
Simple loan process – Along with being easier to qualify for than a long-term loan, short-term loans often have straightforward application processes. They require less documentation and can often be completed online, saving you time. If you do end up with questions, many lenders are happy to help answer them.
Cons of short-term loans
Frequent payments – Long-term loans require a monthly payment, usually in a fixed amount. Short-term loans may require borrowers to pay on a weekly schedule, depending on the type of loan and lender. This means you need to be sure you have the cash flow to cover the payments. If your business doesn’t have a steady income, it may be better to go with a different financing option.
Higher interest rates – Both long-term and short-term loans may come with higher interest rates, depending on the type of loan you get. Since short-term loans are easier to qualify for, including for those with bad credit, interest rates are higher to cover the risk. If you have good credit, you may be able to work with your lender for a lower rate.
Cycle of debt – Short-term loans can be a convenient solution for small businesses that need cash flow quickly, but if they are not paid on time, debt can quickly build up. Be sure you can repay your loan on time and in full; otherwise, you are at risk of default and losing assets.
Short-Term Vs Long-Term Loans – How to Decide Which is Right for Your Business
When it comes to short-term vs long-term loans, figuring out which type of loan to go with will depend on a few factors. For example, if you are a small business that wants to expand locations, a commercial real estate loan would be better suited due to its high funding amount rather than a business line of credit. Typically, the larger the loan you need, the longer the repayment term you will have. If you are short on cash and need some extra financing to stay operational, a short-term loan would be your answer.
If you are having trouble trying to figure out the type of loan your business needs, our financial advisors at SouthEast Bank are here to help answer your questions. We have the knowledge and resources to find the right type of funding for your small business.
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