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Short-term loans can be a quick way to gain funding that you might need immediately. They are often for lower amounts, and are typically due not long after they have been taken out. Short-term loans might include options like payday loans, car title loans, and bank overdrafts. While short-term loans can be a convenient option in some cases, it’s important to know that there are also significant financial risks associated with them.
Read on to explore the various kinds of short-term loans, their uses, and what the advantages and disadvantages of this form of funding are.
- Short-Term Loan Definition
- How Short-Term Loans Work
- Qualifying For a Short-Term Loan
- Benefits and Drawbacks of Short-Term Loans
- Short-Term Loans: Frequently Asked Questions
- Final Notes
What is a short-term loan? We’ll start with a short-term loan definition.
Short-Term Loan Definition
A short-term loan is just a loan with a quick repayment period—usually less than a year. Short-term personal loans are one common form of short-term loan, and are usually used when a borrower needs cash immediately and plans on being able to repay the loan soon after taking it out. Short-term business loans are also available for businesses that need a quick starting boost to get them up and running.
Short-term personal loans may have lower credit requirements than other forms of loan, requiring collateral instead—or they may have very high interest rates as a means of securing funding.
How Short-Term Loans Work
Short-term personal loans work by providing borrowers with cash quickly and efficiently. Rather than the rigorous credit checking and other background requirements often necessary to secure a long-term personal loan, short-term loans use information like your income or require collateral to secure your eligibility for a loan.
When you take out a short-term loan, you’ll give the lender basic information, like your name, occupation, and the amount that you intend to borrow. If you’re approved, you will likely receive the funds you requested within 24 hours.
Typical terms and characteristics of short-term loans
Short-term loans are so named because they must be repaid in a short period of time, usually within six months to a year in most situations. Any loan with a period longer than that is referred to as a medium- or long-term loan. Medium-to-long-term loans can have a term lasting from just a few months to 25 years.
Some short-term loans don’t have a set payment plan or a deadline. They just permit the borrower to repay the debt at his or her own speed. Ultimately, the exact way that short-term loans work depends highly on the lender. Some lenders may have more flexible and accommodating terms. Others might be very strict and have punishing interest rates and penalties for borrowers who don’t conform to the exact terms of the loan. (Find out more in the benefits and drawbacks section below.)
Types of short-term loans
What is considered a short-term loan? There are a few different kinds of short-term loans to be aware of as you begin your search:
- Payday loans: This is one of the more common forms of short-term loan. Payday loans are quick and easy to obtain, but often have very high interest rates. They’re called payday loans because borrowers may effectively promise a portion of their paycheck to the lender in exchange for cash right then and there.
- Car title loans: For borrowers who own their car outright (i.e. don’t owe money on an auto loan for the car), car title loans can be an enticing option. Borrowers use their car as collateral, meaning that if the borrower is unable to repay the loan, the lending agency will possess the car to recoup losses.
- Bank overdraft: Banks charge overdraft fees when an account holder withdraws a greater amount from an account than they actually own. These can be used as a form of short-term loan, but it’s important to know that banks can charge punishing overdraft fees.
- Bridge loans: Bridge loans are used to secure financing for a brief period until long-term financing is secured. For example, consumers might use a bridge loan to secure a deal on property before they have secured their mortgage, or a business might use one to purchase an asset before acquiring a long-term business loan.
- Lines of credit: Lines of credit, such as a credit card, can be considered short-term loans. This is because they require repayment usually within a month of using the credit.
- Merchant cash advance: Merchants may opt for this form of loan to cover assets quickly. Lenders provide merchants with cash, then take a portion of the merchant’s profits until the loan is fully repaid.
Qualifying For a Short-Term Loan
One of the benefits of short-term loans is that they often have less strict borrowing requirements than other forms of medium- or long-term financing. For example, you might not need to have a high credit score in order to secure a short-term loan, which is often a requirement for a traditional personal loan, or even a credit card.
The exact qualification requirements for a short-term loan will depend heavily on the individual lender. Common requirements include proof of income (especially for payday loans), collateral, or consent to a high interest rate.
Benefits and Drawbacks of Short-Term Loans
Short-term loans have some significant benefits for people who need cash quickly. However, it’s important to know that they have significant drawbacks. Before you rush to your local payday lender, carefully consider the benefits and drawbacks of short-term loans listed below.
- Fast cash: The main benefit of this form of financing is that it’s quick, often getting funds into your account within a single day.
- No collateral needed: Depending on the type of loan you apply for, you may not need collateral. Payday loans, for example, do not require collateral. Car title loans, on the other hand, do.
- Bad credit may be accepted, depending on the lender: Unlike personal loans, there are usually much more lax credit requirements for personal loans.
- Not committed long-term: They’re short-term, which can be convenient if you know you can pay it off quickly.
- Some short-term lenders offer payment plan flexibility: Some lenders can be flexible about terms and conditions.
- High interest rates: One of the biggest drawbacks of short-term loans is that they can have significantly higher interest rates than personal loans, often over 50% or even 400% interest rates depending on the lender.
- High fees: In addition to crippling interest rates, short-term loans can have sky-high fees, making the overall cost of the loan extremely high.
- Not a good solution for long-term financing: As the name would suggest, short-term loans do not work well for long-term financing solutions.
- Predatory industry: The payday loan industry is notoriously predatory, taking advantage of people who might not fully understand what they are agreeing to, and siphoning money away from some of the lowest-income and most financially desperate communities in the country.
- Aggressive collection tactics: For those who are late on payments or unable to pay, they may receive persistent calls and even visits by people attempting to collect their debt. This can also lead to punishing fees and interest rates.
Short-Term Loans: Frequently Asked Questions
What is a short-term loan good for? Check out our FAQs to find out.
What is an example of a short-term loan?
Payday loans are a common example of a short-term loan. In this form of financing, a borrower secures funding from a lender by promising to use their next paycheck to pay off the balance of the loan, usually at a high interest rate. Though they are called payday loans for this reason, they may or may not be directly tied to a paycheck.
Are short-term loans good?
Short-term loans may be a solution in some cases, such as needing to cover rent for fear of eviction, or in rare cases of medical emergencies. However, in many cases, short-term loans can be financially risky for the borrower.
Where can I apply for a short-term loan?
Lending agencies often have online applications that you can fill out and receive funding quickly and securely. You may also receive a short-term loan through a payday loan shop, by using a large amount of a line of credit (such as on your credit card) or by overdrafting your bank account.
Short-term loans can be a useful financing option in some rare cases. Short-term loans are effective for covering emergency expenses, or for helping your small business cover initial startup costs before the funding from a long-term financing source has kicked in.
For all your funding needs, there’s Source Capital. Source Capital is a trusted lender with years of experience supplying funding for everything from personal loans to hard money loans to purchase and flip homes. The next time you need funding, work with our experts to get the money that you need on a timeline that works for your personal or business interests.