Synopsis: In short-term loans, the repayment tenure is less than two years, whereas, in long-term, the repayment tenure is more than three years. Continue reading as we explore more about the two types of loans.
No matter how well a company is performing, there are times when managing cash flow can be challenging. For example, when payments are due, and receivables are still outstanding, it's hard to keep your operations running smoothly. These problems are unique to each business, and being able to cover the expenses of tackling them is a key part of your business's success.
It is during such scenarios that short-term and long-term loans come to the business’s rescue. While both these loans have their fair share of similarities, such as lenders needing to follow all government regulations, there are some key differences as well. The most obvious difference between long-term and short-term loans is the length of their terms.
Read along as we go more in depth about these two types of loans, along with the advantages and disadvantages associated with them.
What are Short-Term Loans?
A short-term loan is a loan type used to cover a short-term need for money by an individual or a business and has to be paid off within 18 months. The loan is usually for smaller amounts, which can be anywhere from $100 to $100,000.
Since it is a type of credit, the borrower needs to pay back the principal amount and interest by a certain date. Any loan with a term longer than that is a medium-term or long-term loan. Some examples of short-term loans are personal loans, bank overdrafts, demand loans, etc.
A short-term loan can be helpful, especially for small businesses or new businesses that can't get a credit line from a bank yet. Some benefits of short-term loans for your business are:
Additionally, these loans are good not only for businesses but also for people who have a sudden or temporary problem with their cash flow. For example, if you don't want to take a big order because you don't have enough cash on hand, a short-term business loan can help you pay for all the immediate production costs so you can keep operating.
Pros of Short-Term Loans
Short-term loans are given out very quickly because there isn't much paperwork involved, and the loan amount is small. Here are a few more advantages of short-term loans:
1. Flexibility
Short-term business loans are intended to provide a company with the capital it requires to continue operating. But there are no rules about what the business can do with the money. It can be used to buy raw materials, pay workers' wages, and even advertise. This is extremely beneficial to a small business that does not generally function with a pre-determined structure or spending budget.
2. Quick Funding
They are considered less risky than long-term loans because they are paid off sooner. This is also because the borrower's ability to pay back a loan is less likely to change significantly in a short amount of time. Therefore, it takes less time for a lender who is underwriting the loan to process it. As a result, the borrower can get the money they need faster.
3. Easy Approval
Short-term loans are lifesavers for small businesses and people with less-than-perfect credit. Most of the time, the requirements for these loans are easier to meet. This is because these loans are usually for smaller amounts of money than the money borrowed over a long period.
Cons of Short-Term Loans
1. Higher Interest Rates
Most short-term business loans have higher interest rates because they are much easier to get than other types of loans. You may end up paying a lot more for the same loan amount than you would for a loan with a longer term. So, when choosing a short-term loan company, it's a good idea to look at the Total Amount Repayable (TAR) and the interest rate.
2. Frequent Payments
One major problem with getting a short-term business loan is that most of them need to be paid back quickly. In fact, many of these loans have weekly or even daily repayment dates. Therefore, if your company doesn't have reliable annual revenue sources, you should look into alternative lending choices.
What are Long-Term Loans?
A long-term loan is a type of loan that is paid back over a period that is longer than 3 years. This time frame can last anywhere from three to thirty years. Long-term loans are also generally large amounts which can be used to meet any business or personal need, like buying equipment or a house.
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In the financial world, these loans are the most common way to get credit. Home loans and auto loans are common types of loans now that technology and easy banking have come along. Furthermore, long-term loans can have different features depending on why they are being taken out, such as:
Additionally, long-term loans are approved based on the applicant's regular income, and the lending bank usually wants to see a steady source of income as well as collateral.
Pros of Long-Term Loans
Long-term goals have quite a few advantages like if you don't want to sell part of your business to investors, you can finance its growth with these loans. Here are a few more advantages of long-term loans:
1. Higher Loan Amount
Most of the time, the loan amounts for long-term loans are higher. So, when compared to short-term loans like personal loans, home loans, auto loans, etc., offer larger loan amounts. Since these loans are usually backed by collateral, banks are not afraid to give out large amounts of money to people who want long-term loans.
2. Lower Rate of Interest
Since long-term loans are paid back over a longer period, banks and other lenders charge less interest on these loans. Because of this, rates for car loans and home loans are lower than rates for personal loans. For example, interest for car and home loans can go as low as 8% and 6%, whereas the minimum rate of interest for personal loans is 10%.
3. Tax Benefits
According to the Income Tax Act, there are tax breaks for paying back long-term loans. This depends on the type of loan, though. For example, an auto loan is a luxury loan, so it doesn't get a tax break. A home loan, on the other hand, is a loan for a basic need like housing, so it doesn't get taxed when it's paid back. Under Section 24 of the Income Tax Act, you can deduct up to INR 2 lakh per year from your taxes for the interest you pay on your home loan.
Cons of Long-Term Loans
Although long-term loans have a lot of advantages, they can also put your business at risk and make it hard for you to make money in the long run. Here are a few disadvantages linked to long-term goals:
1. Collateral Risk
For most long-term loans, a form of security or collateral is needed. Borrowers often use a house as security to get the money they need, especially if the interest rates are low. Secured loans may have lower interest rates than unsecured loans, but if you can't make the payments, your assets or home could be at risk.
2. Vulnerability
Along with the risk of losing property, long-term debt makes you vulnerable to the ups and downs of the industry. If your sales drop out of the blue, it can be hard to cover your monthly workforce and overhead costs, as well as your debt payments. If you start to be late on payments, you'll have to pay late fees, and it will hurt your business's credit. Also, if you can't pay back the debt you already have, it's hard to convince lenders to give you more.
3. Restricting Cash Flow
One of the biggest problems with long-term loans is that they limit your monthly cash flow. The more debt you have, the more you have to pay back each month. This means you have to spend more of your monthly income on paying off debt than on making new investments that will help you grow. It also makes it harder to save up money as a safety net to cover unexpected costs of running a business.
Short-term versus Long-Term — Which One is Better?
Even though one loan may seem more appealing than the other, you should apply for the type of loan that best aligns with your business’s needs and future goals.
For example, you're probably counting on a low-interest, long-term loan with a lot of capital, but a short-term loan might be cheaper, easier to get, or just a better choice for your business. This is especially true if your business is new and hasn't been profitable and stable for a few years, which risk-averse long-term lenders need to see from their borrowers.
On the other hand, you might have a credit history and the ability to pay back a long-term loan. No matter what you decide, it can have a big effect on your bottom line.
Apply for a Loan with Protium
In the end, whether you get a short-term or long-term loan will depend on what your business needs. No matter how long your loan is, it's important to work with a lender who knows what your business needs are and what challenges it faces.
To help gain a better picture of the type of loan best suited for your business, consider availing loans from private lenders such as ourselves – Protium. We are a finance company building powerful and transformative financing solutions. At Protium, we offer business loans with zero collateral requirements and affordable interest rates. To know more, give us a call at 8828827800.
