As a small business owner, you have to wear many hats during the early years, and may not have the time or background to be an expert in each of those areas. When it comes to small business funding, however, it’s critical you make the right choices for your business.
You need to ensure your access to capital, without accumulating too much debt, and marry the kinds of funding you can secure with your expenses appropriately, to minimize interest expense or the cost of your business debt.
To accomplish that, there are many different types of small business financing products available, with different loan terms, conditions, amounts, and qualification requirements. One of the simplest to understand, and quickest to be repaid, is a short-term business loan.
Too often, small business owners looking into short-term small business loans see fairly high interest rates – usually higher than longer-term loans – and are immediately turned off.
But that interest rate doesn’t tell you the whole picture, especially if you don’t know the basics of how a short-term small business loan works and the interest is calculated.
To help simply all of this, we’ve put together a brief guide and detailed example of short-term business loan interest rate calculations below.
By the time you finish our guide, you’ll be better prepared to apply for the small business funding you need, and to make the right decisions for your unique business.
Short-Term Small Business Loan Basics
A short-term business loan is largely similar to longer-term loans, which may be more familiar to many small business owners.
At a basic level, you apply and get approved, and are given a lump sum of cash at the time you sign the loan agreement. This cash then can be used however you see fit for your business.
Loan repayment is made through regular, periodic payments, evenly divided over the loan term. These payments consist of principal and interest. When the last payment is made, the loan is considered repaid.
Both forms may require collateral, or may not, depending on what the lender offers.
They’ll both have certain minimum lending requirements, which may vary from lender to lender (and between loans with different terms, as is the case with short-term business loans). Fairly simple!
The biggest difference when it comes to a short-term small business loan is the loan term, as the name itself would imply.
In the case of “ordinary” small business loans, the loan term is usually a matter of a few to several years, even a decade or longer. Repayment is typically required on a monthly time scale over that term.
Short-term business loans have a much more condensed loan term, often on the order of a few months to a year or two at most. Repayment may be monthly, but the shorter the loan, the more likely it is to require weekly or even daily repayments.
Naturally, these will be smaller amounts than once-monthly payments, but the cadence can be challenging for some small businesses.
Interest Rates of Short-Term Business Loans vs. Longer-Term Loans
Both short-term business loans and longer-term loans involve paying interest as part of the conditions of lending – it’s the premium the lender gets for the service of lending you money.
This is factored in to the repayments automatically, based on the interest rate offered on the loan or credit product you utilize. These rates vary based on a number of factors, including market rates, borrower risk, amount of the loan, and more.
But even at the same lender, looking at the stated ranges or average rate offered on a short-term small business loan vs. a longer-term small business loan can be confusing.
On the surface, it often seems like you have to pay a much higher rate to borrow money for a short-term business loan than a longer one. That doesn’t make sense – the lender is getting their money back quicker, so it should be lower, right?
Yes, in fact, that’s largely true. While some lenders do charge more for the higher-risk short-term business loans, it’s usually not a significant difference.
Rather, the disparity between the interest rates on short and long-term loans stems from the way in which interest rates are reported and calculated for comparison purposes – and, in this case, it is unintentionally a bit misleading for borrowers.
Interest rates are expressed as an APR – annual percentage rate – as a standard of measure. This is the effective rate of interest you will pay, per year, across the life of the loan.
Since short-term small business loans have a term that is often less than one year, you can immediately see why this raw number can be confusing and misleading – you’re not going to pay interest for a full year on a six month loan!
So, let’s take a look at a concrete example with real numbers below, as it will illustrate these points more clearly.
Interest Rate Comparison Example
Let’s assume a lender offers a borrower $100,000, at a 12% APR. They can get this as a short-term business loan over six months, with weekly repayment (24 payments total), or as a longer-term loan over 2 years, with monthly repayment (also 24 payments total).
Setting aside things like the time scale on which they need the money and expect to see a return on the investment, which of these options will cost them more in interest expense?
Short-Term Business Loan example:
- $100,000 @ 12% APR
- Loan Term: 6 Months
- Repayment Frequency: Weekly
- Installment Payments: 24
- This means each week, they will be paying a total of $4,288, for a total repayment of $102,910.
- Total interest paid will be $2,910.
Long-Term (Ordinary) Business Loan example:
- $100,000 @ 12% APR
- Loan Term: 2 Years (24 Months)
- Repayment Frequency: Weekly
- Installment Payments: 24
- This means each month, they will be paying a total of $4,707, for a total repayment of $112,976.
- Total interest paid will be $12,976.
Short-Term Small Business Loans from BizFly Funding
Regardless of what market sector you may operate in, when you need short-term small business loans and funding, it makes the most sense to apply at a private lender.
You have better approval odds, will get funded faster, and generally are in for a much simpler and less stressful lending experience. We highly recommend you consider BizFly Funding as your private lender of choice.
BizFly Funding is one of the leading small business lenders in the US today, offering a full range of products, including short-term business loans, longer-term loans, business lines of credit, merchant cash advances, debt consolidation loans, and more.
They are uniquely suited to help you find the right kind of small business funding product for your particular needs, as they only offer small business funding and serve the needs of the small business community exclusively.
To find out more or to start the application process online, visit BizFly Funding at https://bizflyfunding.com.
Frequently Asked Questions about Short-Term Business Loans
Both banks and private lenders are sources you should consider for your short-term small business loans and other small business funding needs.
However, there is an important distinction between these two categories of lenders.
Banks are highly risk-averse in their lending, with many restrictions which naturally filter out the vast majority of borrowers, leaving only the “cream of the crop” eligible and approved for funding.
By contrast, private lenders are much more accepting of risk, and serve a much broader range of the business population and their small business financing needs.
For example, many banks impose high credit score minimums and other requirements, which effectively eliminate 75 to 80% of applicants right off the bat.
Private lenders, on the other hand, relax these same requirements, allowing 50% or more of the credit score spectrum to apply.
As a result, private lenders are often viewed as the better source for short-term small business loans and other small business funding by many business owners.
As with all kinds of loans and credit products, the exact duration or range of loan terms offered to any particular business client will naturally vary from lender to lender.
There are no hard and fast rules about what constitutes a “short term” compared to a long term loan, at least not codified in law or regulations.
However, generally speaking, most lenders offering short-term business funding, including short-term small business loans, have loan terms on the order of a few months on the low end, to around a year or two at most.
This is compared to the multi-year, longer-term loans they may offer, which can span 5, 10, or even 15 years in some cases.
The exact loan term may be negotiable, or your preference requested during the application process at many lenders, to suit your ideal time horizon for repayment or derived revenue/return on investment for the particular short-term business loan you are seeking.
The process of applying for a short-term business loan should not negative impact your credit.
However, as with all loans and credit products, once you sign the loan agreement and the loan is issued, the consequences will largely be in your hands.
If you use the loan responsibly, and repay it on time, in full as expected, then there will be only positive long-term implications for your loan.
Depending on your current loan and credit mix, your credit score may go down when the short-term small business loan is first opened, as you have added to your debt, but will then go up – typically higher than where it started – as you pay off the loan.
The only time you have lasting, long-term damage to your credit score from any kind of loan or small business funding product is if you fail to repay it on time or in full, as stipulated in your loan agreement.
Every lender has their own set of criteria and minimum eligibility requirements to qualify for any kind of loan or credit product with their firm, and this holds true for short-term small business loans as well.
Most lenders specify a minimum credit score requirement, minimum time in business requirement (usually, several months to a year), and a minimum monthly revenue requirement as well.
Additional documentation requirements are typically part of the loan application process. Some regional, state, or national restrictions on lending may apply, based on the territory and rules under which the lender operates.
If you are seeking a secured loan, then collateral is also required. Unsecured loans, including many forms of short-term business funding offered by private lenders, do not require collateral in order to obtain the loan.
There are a few different standard options among common small business funding products and services which can work well for short-term business funding.
Obviously these options include the aforementioned short-term small business loans.
Additionally, a business line of credit can be used as a short-term financing option, though is generally harder to qualify for than a short-term business loan, which in turn is harder to qualify for than a longer-term loan.
Finally, a merchant cash advance can be used for short-term financing.
A merchant cash advance is not a loan exactly, but rather a case where you pre-sell future debit and credit card sales at a discount, in exchange for up-front cash.
There is no specific loan term associated with a merchant cash advance, as repayment is made automatically as a deduction from those future card-based sales.
This makes it open-ended, with repayment responsive to your sales revenue, rather than the calendar.
For this reason, many sales-driven businesses find merchant cash advances preferable to short-term small business loans when revenue is highly variable, seasonal, or cyclical.
