When you need a business loan, one of the biggest decisions you’ll face is whether to opt for long-term or short-term finance. Each option has its advantages and drawbacks – so how should you decide?
Term loans are the most common form of business financing, but it’s important to work out if long term or short term business loans are best for your business and its individual needs. Both differ in terms of eligibility requirements, loan amounts and interest rates charged.
Differences in term length
For a short-term business loan, you will usually need to repay the amount (plus interest) within 3 to 12 months. The length of a long-term loan will depend on the lender you are speaking to but are much longer in length. Long term loans will often also require the borrower to lend against collateral such as equipment or property assets due to the increased risk and often higher amounts of funding.
Differences in the amount you can borrow
The other difference between long- and short-term loans are the amount you can borrow. Often short-term loans are anything up to £250,000, with longer term loans stretching to double that amount. Whilst the term time lengthens and the risk increases, so does the risk and the eligibility requirements.
Differences in interest rate
Short term small business loans are more often provided by alternative lenders these days and for this reason they usually come with higher interest rates. The higher interest rate covers the risk as well as regularly lending to those with lower credit scores. You will also pay more for a quick short-term loan which in many cases you will be able to receive the funds in your account within 24 hours.
The APR (annual percentage rates) include both the interest on the loan and any additional fees that the lender adds based on risk. Whilst short term loans will generally have a higher interest rate, the longer you hold on to the loan the more it costs you so in many cases you will still find that a long-term loan costs you more.
Which is right for you?
Many businesses will assume a long-term loan is more preferable as you have longer to repay and a lower interest rate. However, it is not always as easy to get a long-term loan and they are much harder to qualify for with a more detailed application process.
Longer term loans are particularly difficult for small businesses to attain who haven’t been operating for long and don’t have a solid credit rating behind them. “We frequently find that smaller businesses don’t actually need long term funding and short term fixes such as working capital loans or equipment loans are all that is required to get them through a short term cash flow problem” comments Managing Director of Cashsolv Carl Faulds.
Short term loans will help you deal with unexpected situations. If you need money quickly to fund a short term cash flow problem, operate a seasonal business, need to purchase more stock to facilitate a big order which you won’t be paid for just yet, your equipment has broken and you need it replaced quickly, or you simply want to fund a marketing campaign for a new product launch then a short term business loan is going to be right for you.
Longer term loans are more suited to big ticket purchases that are going to last for a long period of time. They are ideal for funding long-term projects or strategic initiatives such as opening new offices. Never undertake a term loan where repayments will long outlive what you are seeking funding for.
Any type of loan that you take out needs to help grow your business at the end of the day. Its important that you understand the repayments and if you can afford any type of business loan. Always use a loan calculator to work out your repayments and affordability. Most importantly you should know how the money is going to be spent before applying and ensure your investment will be worthwhile.
Written by Carl Faulds
As Managing Director of Cashsolv, Carl offers advice and support to overcome cash flow problems and identify possible underlying problems that can be addressed to ensure a positive future for your business. Carl was former president of the Insolvency Practitioners Association and makes regular appearances on BBC documentaries related to business recovery.