Question

Discuss the risk of a long-term versus a short-term loan. What is the risk to the lender and the borrower? During the current rate environment, what would make more sense for your company? Why?

Answer 1

There are pros and cons for both long term and short term loans. The list is as follows:

Long Term Loans - Pros:

* Of course, the most obvious advantage of the long term loan is the loan amount. If you qualify, long term bank loans are used to start a business, purchase a car, buy a home, consolidate debt and anything in between.

* Long term loans typically come with more competitive rates than short term loans. Banks are extremely competitive with each other and they often offer interest rates that are more appealing than what their competitors offer.

* Long term loans -- because they are spread out over a lengthy time period -- include relatively small monthly payments.

* Some banks will also offer balloon loans where there are little or no payments until the loan is due. At the due date the balloon payment is made. This is beneficial for a borrower who may be launching a business with a small amount of capital, but there is significant growth potential for the business or investment.

Cons:

* The application process is very cumbersome and time-consuming. There are numerous lengthy forms to complete and the financial institution will ask a lot of personal financial-related questions.

* Interest adds up. Although the payments are spread out over a long period of time, and the interest rate may seem low, the interest adds up and the total amount repaid may be almost double the loan amount or more, depending on the length of the loan, the interest rate and the amount borrowed.

* Risk. If you have trouble paying off your loan, you risk losing your property: your car, your home, etc.

Short Term Loans - Pros:

* Simplicity. One of the major reasons why short term loans such as payday loans have become so popular is the ease in which a consumer can obtain the loan. This is especially true for online payday loans. There are an abundance of payday loan vendors online, and the application process and electronic transmission of the loans are extremely user-friendly.

* Speed. Short term loan applicants are typically informed immediately whether they qualify. And, as soon as the borrower agrees to the loan terms, the money is usually transmitted to the customer's bank account within 24 hours.

* Weak credit is OK. Oftentimes, customers who have been rejected for loans from a bank due to credit issues will have an easier time qualifying for a short term loan. With payday loans, for example, customers can qualify as long as they have a steady source of income and no other outstanding payday loans.

* Short term. As the name implies, the short term loan is designed to be repaid quickly -- usually within 8-24 days. When repaid promptly, the debt -- and the customer's financial problem -- are quickly resolved.

Cons:

* Short term = small loan. Borrowers can usually only take out up to around $1,500; and that figure is typically much smaller until the borrowers have established themselves as a good customer. Therefore, short term loans can only be used to pay for minor expenses such as bills, car or home repairs, etc.

* Interest rates. One of the most common criticisms of short term loans is the annual interest rate (APR). Although state regulations usually prevent borrowers from rolling over short term loans for more than around two months, the APR (which is about 400 percent) scares off some consumers.  

It is important for consumers to understand the benefits and the pitfalls of all available loan options. In addition, borrowers must be very disciplined when it comes to their outstanding debt. Make sure you stay within your budget and do not get over-extended financially.

Which is the best?

Ultimately, which type of funding option is best depends on your specific business needs. For most small business owners, a short-term loan will likely be more suitable. However, sometimes long-term financing may be necessary.

Either way, it’s important to work with a lender who understands the workings of small businesses and can tailor your loan to support your success.