June 27, 2023 | Last Updated on: September 13, 2023
When looking for financing, small business owners often have to decide between long-term small business loans and small business short-term loans. But there is no simple answer to the question of “What is better . . . short-term or long-term loans? The ultimate decision, of course, is based on the more pressing needs of the small business and weighing the pros and cons.
For instance, for a seasonal business in need of a quick influx of cash to meet current expenses, a small business short-term loan can be the answer. For businesses looking to upgrade their current location or to acquire a new location, a small business long-term loan can provide the necessary amount of money.
By definition, a short-term loan for small business comes with a shorter repayment period. As such, they don’t require a longer-term budget commitment. This is just one reason why, when it comes to small business loans, short-term business loans are the preference of some small business owners.
Long-term loans typically are provided by banks, credit unions or another traditional lender. These loans come with much larger loan amounts than short-term loans. This, in turn, means that the length of the repayment terms for borrowers will be much longer than those of a short-term loan. For example, the repayment terms of a long-term loan may range between 10 to 20 years, and even up to 30 years. The terms of many long-term loans, however, can run from three to 10 years.
What is a short-term loan? A short-term loan is an unsecured loan suitable for small businesses that may have a temporary cash flow issue. The loan amounts are normally small, ranging from $500 to $10,000, and can have repayment terms of six months to 18 months. Short-term loans are generally provided by alternative online lenders.
These loans can be a viable financing option for small businesses that cannot yet qualify for a line of credit from a bank. While approval and funding can be quicker with a short-term loan, the downside if that small business short-term loan rates can be higher. Short-term loans can also charge additional fees.
Since repayment terms of long-term loans are longer and loan amounts are greater, it’s not uncommon for collateral to be required for a long-term loan. Collateral is an asset that the small business offers to secure the loan. Should the business owner default on the loan, the lending institution can then seize the asset.
Short-term loans are typically unsecured and don’t require collateral, given that they feature lower amounts and shorter payment terms. These amounts and terms also lend themselves to making short-term loans a good solution to meet the working capital requirements or daily operational needs of a small business.
When considering the types of business loans, long-term loans can be a good resource for businesses to finance the purchase of assets, expansion of the business and to help the business grow through solving business needs.
Since revenue derived from such long-term planning is normally generated over a longer period of time, it allows businesses to pay back long-term loans over a much longer time period.
One advantage of a short-term business loan as a loan option is that it allows small business owners faster access to the funds they need. Small short-term business loans are available to not only help small business owners get financing quicker to avoid financial pitfalls, but to pay it back faster and get out of debt.
The same quick approval time and fast access to financing that makes short-term loans so attractive to small business owners also comes with risk. That’s because small business owners may be tempted to refinance and roll their debt into a new loan. This process can potentially trap a business in a cycle of debt, cutting into its cash flow and profitability.
Long-term small business loans typically come in much larger amounts and are repaid over a much longer period of time, which can potentially saddle the business with debt for decades. In addition, the strict and lengthy application process and approval process for long-term loans can make it difficult for a business to qualify for a long-term loan. Thus, short-term financing may be their only option.
Simply put, the fact that short-term is settled more quickly can make it more advantageous than long-term debt.
While small business loans short-term rates may be higher, the loans are repaid sooner. This means that small business owners are typically paying less interest on these shorter-term loans than they would with a larger long-term loan that would take longer to pay off.
SBA loans are primarily long-term small business loans that feature long repayment terms. There are a variety of SBA loans available, all with different repayment terms, but all fitting the definition of a small business loan long-term.
The popular SBA 7(a) loan, for instance, offers a maximum loan amount of $5 million with repayment terms ranging from 10 to 25 years. If the 7(a) loan is used for working capital or to purchase inventory, the small business has 10 years to repay the loan. Small businesses that use the loan to purchase equipment also can expect a repayment term of 10 years. For 7(a) loans used to purchase real estate, repayment can be extended to a term of 25 years.
Their flexible repayment terms and low interest rates make SBA loans an efficient way to fund a small business. But it can be difficult to qualify for SBA loans due to their tight lending requirements. SBA loans are issued by a private lending institution, such as a bank or credit union. The loans are partially guaranteed by the SBA.
As a result, the SBA requires an unconditional personal guarantee from all business partners with a stake of at least 20% equity in the company. This means that the personal assets of the small business owners can be seized for payments should the business default on the loan.
In addition, the SBA typically requires collateral as security on most SBA loans when legitimate assets are available. Equipment, buildings, account receivable, business vehicles and even inventory can be considered collateral to secure the loan. And while SBA policies can be flexible on the issue of collateral for loans between $25,000 and $350,000, the SBA requires the maximum amount of collateral from the small business owner for loans larger than $350,000.
Among the other common loans offered by the SBA are:
In addition to the SBA 7(a) loans, the SBA also has an expedited processing service for smaller loans which is called the SBA Express loan. This loan features the same basic template of the 7(a) loan, but only select lending institutions are allowed to participate and the maximum loan amount is $350,000. Interest rates are higher for the SBA Express loan, mainly because the SBA guarantees a maximum of 50% of the loan.
This program provides SBA loans to small businesses that want to build or buy owner-occupied commercial real estate. It also offers long-term, fixed-rate financing for other major fixed assets. In doing so, it couples a bank or other traditional lender with a community development corporation (CDC). The bank contributes up to 50% and the CDC up to 40% with the balance provided by the small business that is applying for the loan.
CDC/SBA 504 loans can be used for the purchase or construction of existing buildings or land, new facilities and long-term machinery and equipment. They can also be used for the improvement of existing facilities, land, streets, parking lots, landscaping and utilities.
In most cases, the maximum loan amount for a CDC/SBA 504 loan is $5 million. For certain projects in the energy sector, a business can qualify for a CDC/SBA 504 loan for up to $5.5 million per project.
Three different varieties of SBA export loans comprise this program: Export Express, Export Working Capital, and International Trade. All of these loans are approval requirements similar to the SBA 7(a) program. The loans offer small businesses the chance to acquire funding that might not be accessible through traditional loans. The goal of the program is to encourage American small businesses grow their export operation and increase their activity in foreign markets.
Through the SBA microloan program, the SBA makes loans available to small businesses and nonprofit childcare centers through nonprofit intermediary lenders. Microloans are also the best funding option for small businesses seeking small business loans with bad credit. Microloans are typically under $50,000 and the SBA doesn’t guarantee any of the loans made under the SBA microloan program. Microloans have terms of up to six years, and the average amount of the loans is approximately $13,000.
Collateral is not required for small business owners who are seeking an SBA loan of $25,000 or less. But, even in such cases, the SBA still requires the personal guarantee from all small business owners who have at least a 20% equity stake in the company.
The SBA loans that are most likely to be unsecured are the popular 7(a) loan, which is the most common type of funding backed by the SBA, or the CDC/504 loan. The CDC/504 loan collateralizes the property being acquired through funding. This, in turn, allows small business owners receiving this type of loan to avoid offering other collateral.
For small business owners who don’t meet the strict underwriting requirements of SBA loans, need financing quickly, don’t need long-term financing or who don’t have worthwhile assets to offer as collateral, it may be possible to qualify for an unsecured small business loan through alternative online lenders. The downside of a short-term loan is that they charge higher interest rates or fees for small business loans. But it’s uncommon for short-term loans to include collateral.
Online lenders can be a valuable resource of financing for startup businesses. Since they have no proven record of revenue, startup businesses can find it difficult to acquire the funding they need. But alternative lenders, in many cases, are willing to soften their requirements for approval. They may be willing to accept lower credit scores and less of a successful business history. But, again, this flexibility typically comes with higher interest rates and fees.
In addition to term loans through online lenders, there are other small business financing options that don’t include collateral. These include merchant cash advances and unsecured lines of credit.
This funding option can be a good fit for startup business or a company that hasn’t been in operation for a significant period of time. Small businesses that qualify for a merchant cash advance receive a lump sum of money upfront in exchange for a portion of their future income.
Rather than paying monthly interest similar to a loan, merchant cash advances are repaid in factor rates, which is a daily or weekly percentage of the revenue of the business. Since the rate of repayment isn’t fixed, a merchant cash advance can eventually cost more than anticipated.
Unlike a long-term or short-term loan which is for a specific dollar amount and is repaid at regular intervals, an unsecured line of credit allows small business owners to borrow as much as is needed – whenever it’s needed – up to a given pre-determined amount. As the balance of the amount borrowed is repaid, the amount of credit available to the business is restored. As a result, the business can continue to borrow against the line of credit.
