Perhaps you know a thing or two about short-term loans, but you probably don’t know the whole picture. While they make sense in some situations, they don’t in others. Recognizing when to pursue them and when to avoid them will help you make smart personal finance and investing decisions.
What is a Short-Term Loan?
As the name suggests, a short-term loan is a type of personal loan that’s extended to a qualified borrower with a required repayment term typically within 90 days or less (though they can extend up to a year).
Because of the short-term nature of the payback period, these loans are typically only given in small amounts to borrowers who meet certain requirements. Once applied for, these loans are typically approved or denied within hours. The money is then immediately transferred into the borrower’s account.
According to data from The Online Lenders Alliance, the median household income for short-term loan borrowers is somewhere around $30,235. This suggests that this type of loan is largely used by low-income consumers. The median short-term loan amount is $428, with a median cost for a loan (interest and fees) being $113. On average, short-term loan borrowers pay off their debt in three to 12 months.
When Do Short-Term Loans Make Sense
Short-term loans are often just what the doctor ordered. Here are a few situations and factors that make them ideal:
- If you’re living paycheck-to-paycheck and simply don’t have the cash to pay for something that you need right away – but know you’ll have the money within a few weeks or months – a short-term loan can keep you afloat.
- Short-term loans are extremely flexible. There are very few stipulations (if any) on how you can spend the money. This makes them ideal for situations when other types of loans (such as a home equity loan) won’t suffice.
- Short-term loans are helpful for small business owners – particularly those who run seasonal businesses or high-volume, small-dollar sales companies.
- Are you in between jobs? If you’re no longer receiving a paycheck from your previous employer, but have to wait a couple of months before getting a paycheck from your new employer, a short-term loan may bridge the gap and allow you to meet basic expenses.
These are just a few examples of times when short-term loans come in handy. Understanding when they’re helpful will allow you to make smart financial decisions that benefit you both now and in the future.
When Should You Avoid Short-Term Loans
While there are plenty of scenarios where short-term loans work to your benefit, there are also numerous occasions where they don’t. Here are some examples of when they don’t make sense:
- Did you know that a short-term loan is the most expensive type of debt you can carry? While this is fine when the repayment term is something like 30 days, it can add up when you wait six or nine months to pay the lender back.
- A short-term loan is designed to cover you for a very brief period. If you have a long-term need, this type of loan product isn’t going to work for you.
- Ironically, you need some cash on hand when taking on a short-term loan. Having nothing in the bank will set you up for major challenges when it comes time to repay the loan.
As you can see, a short-term loan isn’t always the answer. There are times when another loan product will be better for you.
How to Find the Best Short-Term Loan for Your Situation
If you decide that a short-term loan is right for your business, you’ll need to begin researching your options. There are plenty of products and lenders on the market, so be sure to do your due diligence and compare your options.
You can find short-term loans from local banks and credit unions, as well as online lenders. Typically, online loans process faster and offer slightly more on the loan amount. Loans from physical lenders, however, may be easier to obtain if you already have an existing relationship with the company.
The biggest key is to avoid making a rash decision. Analyze at least two or three different options before signing the dotted line. This will give you a better idea of your choices.