Council Post: Long-Term Vs. Short-Term Loans: Which Is Better For Your Business? (2024)

FAQs

Council Post: Long-Term Vs. Short-Term Loans: Which Is Better For Your Business? ›

Long-term loans tend to carry less risk for the borrower, but interest rates tend to be at least slightly higher than for short-term loans. Long-term financing is typically used to cover equipment purchases, vehicles, facilities, and other assets with a relatively long useful life.

Short-term loans versus long-term loans

Shorter loan terms typically mean higher monthly mortgage payments, but often have lower interest rates. And if you pay off your mortgage balance within a shorter term, you may pay less in interest overall than with a longer-term mortgage.

Essentially, the type of capital companies select will depend on the needs of their business. Long-term capital is better-suited for external and internal strategic investments as well as financial risk management, in contrast to short-term capital, which is best used for every-day, operational needs.

Short-term business loans can offer business owners funding to bridge a brief gap in their cash flow. You'll generally get the money fast, but you'll also need to repay it quickly. Evaluate your cash flow and make sure you can keep up with the rapid repayment terms that come with these types of loans.

Some of the biggest benefits of choosing longer repayment terms on personal loans include the following: Your monthly payments are lower. The longer you take to repay your loan, the lower the monthly payments will be. Say you take out a $10,000 personal loan at 10% interest.

There are several risks that are involved with investments which is why the stock market has a 50:50 success rate. It is for this reason, that short-term equity investments are considered as risky, whereas long-term investments are considered much more profitable and consistent in terms of returns.

A business might make use of short-term finance to take advantage of an opportunity that may pass them by, otherwise to cover unexpected costs, or to resolve a cash flow issue. These funds can be used for any purpose including purchasing supplies or inventory, making upgrades to infrastructure or anything else.

Interest charges — ripping off the Band-Aid

The downside to choosing a personal loan with a longer repayment term is paying more in interest charges over the life of the loan. Since lenders charge interest payments monthly, a longer loan term inherently means more interest payments.

Here are the main messages regarding firms' use of long-term finance: Firms tend to match the maturity of their assets and liabilities, and thus they often use long-term debt to make long-term investments, such as purchases of fixed assets or equipment.

The first con of long-term financing is that it can result in a higher interest rate. So while the lender can look forward to a stream of income for a more extended period, on the other hand, they'll be facing long-term risk too. As a result, they increase the interest rate to earn from the increased risk they take.

Why would a business need a long term loan? ›

Long term financing is particularly useful for large capital investments and projects which require access to working capital over prolonged timelines.

According to the most recent data from the Federal Reserve, average rates on business bank loans fall from 6.13% to 12.36%. Ultimately, the interest rate you receive will depend on the loan type, lender and your business's qualifications, among other factors.

It may seem like lenders would prefer longer loan terms due to the higher total interest fees. But longer loan terms can be risky for lenders. Personal loans often have a fixed interest rate, meaning it does not change throughout the loan term.

The benefits of long-term investing

Compound growth is the return earned not only on your initial investment, but also on the returns you receive during its lifetime and reinvest back into it. If you're only investing for the short term, you won't see the full potential gains of compound growth.

These loans are considered less risky compared to long term loans because of a shorter maturity date. The borrower's ability to repay a loan is less likely to change significantly over a short frame of time. Thus, the time it takes for a lender underwriting to process the loan is shorter.

Short-term financing is somewhat riskier than long-term, but it also tends to be less expensive and offers greater flexibility to the borrower. Both the increased risks and the lower rates are due to the potential for future interest rate fluctuations.

Final thoughts on long-term investing vs short-term

Both approaches have their potential benefits, but long-term investing potentially provides an increased chance of a higher return through compound growth and the recovery of losses over time.