What is the difference between long-term business loans and short-term business loans?
The main difference between a short-term business loan and a long-term business loan is the length of time repayment. But, there are reasons why a business owner would choose one or the other — and whether or not they'll be offered both. Credit, time in business, financial statements, and cash flow play a significant role in which, if any, will be offered to a business owner. Both products can be great options depending on the qualifications and needs.
Difference Between Long Term and Short Term Business Loans
The two biggest drivers for a business owner when choosing short-term vs. long-term business funding are the business's qualifications and, more importantly, the use of the money for the company. The criteria for long-term business loans are more complicated and demanding than short-term ones, but they offer the most affordable rates and terms if qualified.
Make no mistake about it; long-term financing is not for every business owner and may not be a realistic option, so don't count short-term business funding options out because it may be the best available. Business funding is not a one size fits all approach.
Let's compare the two so you know how they work and determine the best options available for your business.
Long-Term Business Loans
To dive further into the differences between long-term and short-term business goals, let us look deeper into each component. Below, we discuss the factors that come with a long-term business loan.
How Do Long-Term Loans Work?
Long-term business loans are defined as loans that have repayment terms of greater than one year in business with monthly payments. These types of loans have lower interest rates and longer terms than other types of business funding products, so they are very desirable because they are more affordable. However, there is always a catch in that they are a lot harder to get approved for. Let me explain the requirements and features.
What are the Loan Amounts Available for Long-Term Business Loans?
Due to the attractive terms, many long-term business lenders require a minimum loan amount because of the low rates and length of the term, which creates risk in of itself. Typically you will see loan amounts at a minimum of $25,000 and capping in the area of $500,000. But with banks and the proper financial statements, you can see amounts in the millions if the business is generating enough revenue and profit.
What are the Loan Repayment Terms for Long-Term Business Loans?
The length of time to repay for long-term business loans vary, but one could expect a minimum of 1 year and up to 7 years, with the exception of SBA loans, which can be up to 25 years with the proper qualifications.
What are the Long-Term Rates for Long-Term Business Loans?
Rates for long-term business loans are based on principle and interest and are wide-ranging from 4% up to 29%. You may be asking yourself why such a big range in interest rates. Well, long-term business loans are risked based, so all of the requirements and documents requested are evaluated to generate an overall risk score, which will then relate to the rate you will be offered.
What are the Credit Requirements for Long-Term Business Loans?
This is not an easy answer. Many times business owners will inquire about what personal FICO score they need to qualify, and a general rule of thumb is FICO scores need to be above 680, but that's not necessarily true, as credit evaluation is more than just a FICO score. Since the financial crisis of 2008, financial institutions have gotten smarter and read the credit themselves using their own credit algorithms. So, they actually care if you have a mortgage history, installment loans, or revolving credit like credit cards, and formulate their own scoring model. It is true still that the better the credit, the more likely the overall terms will be better, such as interest rates and length of time of repayment.
What are the Revenue and Collateral Requirements for Long-Term Business Loans?
Revenue requirements typically begin in the range of $250,000 annually. Business Lenders have discovered over time, with all things remaining equal, like credit, that the more revenue the business does, the greater the likelihood of repayment, and the greater the fees they earn off interest for the risk. Keep in mind; the work business funders do irrelevant to the loan amount, so the lender can earn a lot more money on larger loans than smaller loans for the same amount of work to approve as well as service that loan. In some cases, larger business loan amounts tend to have better rates than smaller business loans for that reason.
What is the Financial Statement Required for Long-Term Business Loans?
Long-Term business lenders will be considering the profitability of a particular business when making business loans. Unlike short-term business funders, you will be required to supply documents such as business tax returns, year-to-date profit & loss, balance sheets, accounts receivables, and accounts payables. Not all long-term business loans will require all of the above, but you get the gist the profitability matters for these products and will impact eligibility.
What are the uses for Long-Term Business Loans?
Typical uses of long-term financing are the purchase of equipment, renovations to a facility or business, long-term projects which will take time to reap the benefits with delayed incoming revenue, or large amounts that require long terms to make the payment affordable for the business.
Who offers Long Term Business Loans?
The following entities provide long-term business financing;
- Federal, State Banks
- Credit Unions
- Approved Lenders/Brokers who offer SBA (Federal Small Business Administration-backed) business loans
- Long-Term Business Lenders
- Business Loan Brokers
Short-Term Business Loans
Let us now look into short-term business loans and the key factors within them.
How Do Short-Term Loans Work?
Short-Term business fundings such as short-term business loans, Future Sales Receivable agreements(MCA's) are defined as loans or fundings that have repayment periods of 4 months to 18 months with weekly or daily payments and have higher approval rates than that of long-term business loans. There is always a catch, though, in that they are a lot more costly and shorter-term than that of long-term business loans.
These types of funding have costs (known as factor costs, not principal & interest rates) that are higher than that of long-term business loans and cost more because they typically are taking on higher risks with lower credit standards, and minimal paperwork to review than other types of business funding products. Therefore, they are very desirable to business owners because they are more likely to be approved for them.
What are the Loan Amounts available for Short-Term Business Loans?
To reduce risk, short-term business funding ranges from as little as $5,000 up to $500,000. The higher the amount, the more likely the business lender/funder may ask for additional information other than just bank statements. Higher than $500,000 can be difficult to find due to the greater risk associated with more lax credit standards of short-term business financing.
What is the Loan Repayment term for Short-Term Business Loans?
The length of time to repay will typically be in the range of 4 to 18 months due to the greater risk associated with more lax credit standards of short-term business financing.
What are the Long-Term Rates for Short-Term Business Loans?
It's very important to know that short-term financing products typically have fixed costs known as factor rates, which are very different from the principal in interest-rate loans. It's generally a fixed cost associated with the business funding whether you pay it off earlier or not, unlike principal & interest business loans. You get a fixed cost rate that ranges from 8% to 45% of the loan or funding amount.
For a Factor cost example;
$10,000 loan amount X 1.25% Factor Cost is a payback cost of $12,500. The difference between the loan amount and the payback cost is $2,500, which is your factor cost or interest.
Some of these products offer an early pay discount, which is a percentage off of the payback. This varies from lender/funder but is not the same as principal & interest remaining. Therefore, it's important to weigh the cost of the money versus the benefits that money will provide to your business.
What are the Credit Requirements for Short-Term Business Loans?
The good news is that short-term business financing allows the business funder/lender to take on higher risks by lowering credit standards because, quite simply, they are getting their money back faster than longer-term products! Fico credit scores can go down to Subprime levels as low as 500 and as high as credit scores can go. Better the credit the lower rates and costs associated with short-term business funding products. So, the business owner's credit rating does matter when trying to get the best offers.
What are the Revenue and Collateral Requirements for Short-Term Business Loans?
There is more flexibility in revenue requirements than that of long-term business loans, and personal collateral is rarely required. Generally speaking, a business must deposit a minimum of $10,000 per month in sales through a business bank account month over month to qualify, but certainly, there is no limit to the amount of revenue that a business will deposit annually.
What is the Financial Statement Required for Short-Term Business Loans?
In general, the requirements for short-term financing are much less than the long-term alternative. The only requirement from a paperwork standpoint is 3 to 4 months of business bank statements to be able to qualify for business funding. Some products may also request Merchant Processing Statements (if applicable) or business tax returns if an amount requested reaches a certain point. There can also be requests for additional bank statements and/or account receivable reports if there is some seasonality to the business
What are the uses for Short-Term Business Loans?
By far, the biggest reason for short-term financing is business working capital. Managing business cash flow is a challenge, no matter the size or type of business. Short-term business financing allows the business owner the ability to re-access needs throughout the year. Other uses include needs that could not be eligible for financing through long-term products like business loan expansion, equipment, supplies, software, etc.
Who offers Short-Term Business Loans?
The following entities provide long-term business financing;
- Short-Term Business Lenders/Funders
- Online Business Lenders
- Business Loan Brokers
I think the big elephant in the room is simple. Long–term financing is clearly more appealing because it offers the ability for the business owner to access more capital at more affordable terms.
But life isn't that simple, is it? Long-term financing is not for everyone whether you want it or not! It's difficult to qualify for long-term business loans. Period, Full stop. It is not an option for many business owners; especially the smaller business so don't go thumbing your nose at short-term lending products because it's the fastest-growing segment of the business funding market as of 2020 for a reason.
The true answer is that short-term and long-term business loans are both valuable tools that need to be explored and evaluated to determine what is the best available option and solution to solve the problem, which is acquiring money for the business. So, take your time, explore, evaluate, compare, and then decide.
One thing is for sure, there will be times when the ability to grow your business will require the capital to do so, so be a good detective and discover the possibilities that fit best.