Definition of Short Term Loan
Short term loan can be defined as temporary or short term unsecured borrowings undertaken to fulfil short term business, personal or working capital requirements which will be repaid over a period no longer than one year and are usually presented under the current liability section of balance sheet.
A short term loan is a form of short term finance which enables the user to gain instant liquidity for meeting out his short terms business or personal requirements. Short term loans can be undertaken from any financial institutions (FI) like banks, NBFCs. Institution granting loan charges interest and processing fees in the form of consideration against funds granted. These are an attractive source of funding for startups and small business as they may not be in a position to avail long term loans from banks and FIs. Value of loan sanctioned is generally low which ranges from $100 to $1,00,000. Short term loans are not only beneficial for business but also for individuals to meet out their sudden or temporary financial requirements. Short term loans are generally utilized to supplement day to day business operations and meet out working capital requirements. Example, to pay of suppliers in the case where accounts receivables are yet to be realized. Quantum of the short-term loan availed helps in understanding and analysing the company’s working capital management efficiency level. High short-term loan indicates liquidity issues of the entity. If the short term borrowings are more than the cash and cash equivalents, this might suggests that the company is in poor financial condition and don’t have sufficient cash to pay off its obligations.
Characteristics of Short Term Loan
- Higher Rate of Interest: These loans are quite expensive as banks and FIs charges high-interest rates on such loans and advances.
- Low Amount Borrowed: Amount of loan sanctioned in these loans is always lower than another type of loans.
- Unsecured: These loans are generally unsecured in nature, as the borrowing amount and the repayment time is less, therefore collateral security may not be asked for. However, some banks and FIs may ask for collateral security.
- Tenure: Short term loans may be having tenure of one month, quarter or a year. Entire interest and principal needs to be repaid within this time limit.
How to Apply for Short Term Loan Online
To apply for short term loan one has to follow the following steps –
Step #1 – Register on the platform: In order to avail a short term loan one has to find a suitable credit lending agency and understand its terms and conditions. If it suits the entity’s requirements, then one must register on its portal online.
Step #2 – Fulfil KYC details as per the government requirement: The next step is to submit basic borrower details along with his necessary documents by which KYC can be done like a passport. The document submitted must clearly mention the details of the borrower his name address etc.
Step #3 – Submit the income documents and bank statements for the last six months: For determining the maximum amount which can be granted, banks, FI requires a potential borrower to submit income details so as to determine person’s repayment capacity. Accordingly, documents like tax return and bank statements must be uploaded at the portal.
Step #4 – Credit assessment: In the next step the lending agencies undergo credit assessment by reviewing all the documents uploaded by the borrower.
Step #5 – Sanctioning: If a person is found appropriate, banks sanction loan to eligible clients.
Step# 6 – Disbursement: Next step after loan getting sanctioned is disbursement. At this stage, money gets transferred to borrower’s bank A/c.
Types and Examples of Short Term Loan
- Line of Credit: Line of credit is a financing term used by a bank or any financial institution which determines the maximum amount of loan or advance that can be granted to a borrower based on his creditworthiness. It is up to the borrower to withdraw the whole loan amount at once or to withdraw in instalments according to his needs. Charges will incur only on the loan amount withdrawn and not on the sanctioned amount. When the borrowed amount is repaid his credit is refilled with the sanctioned amount. For example, Sam, who has a high credit score is eligible to have $50,000 whereas Tom who has low credit score will have only $30,000 eligibility.
- Bank Overdraft: It is a line of credit provided by the banks to its customers. Overdraft limit is prefixed by the bank. If in any case, the borrower’s funds are falling short to cover a payment made, the bank will cover the deficit amount by extending its overdraft facility. Example, when a company is having an account balance of $1,000 and writes a cheque of $2000. The account will be overdrawn by $1000 when the cheque is cleared. In this case, the company has an agreement with the bank for an overdraft limit (short term loan) so due to this facility, the cheque of the company will get cleared otherwise it would have been bounced due to unavailability of sufficient balance.
- Merchant Cash Advances: This funding facility is best applicable for businesses having large credit /debit card transactions instead of cash transaction. In this case, the bank or financial institution agrees to provide a lump sum amount in advance to the borrower. This amount is gradually recovered by the bank as a percentage of sales of the borrower. For example, when a sale is made by the borrower a fixed percentage say 2% will be directly recovered by the bank from the payment initiator.
- Payday Loans: This is suitable for event based businesses or individuals under which amount of loan granted is recovered from the next credited salary or other income as agreed by the lender and borrower.
Short Term Loan Periods
Period of short-term loans may vary depending upon the type of loan granted. Some may fall due by next week, month, quarter or year. However, there is not hard stone based time limit of one year. Some banks and FI may even consider loan period of 2 or 3 years as short-term loans.
Advantages of Short Term Loan
Some of the advantages are:
- Easily Accessible: These are easily available to small business and individuals without much complications. These act as lifesavers for small businesses who have a lower credit score.
- Instant Approvals: Approval process is quite simple and do not require lengthy processes as compared to long term loans. The risk here is low as compared to other risky loans as the duration is short here.
- Low-Interest Cost: The repayment period is shorter here therefore interest cost is lower.
- Increases Credit Score: Borrowing such loans and repaying them on time will increase credit score and creditworthiness of the borrower.
- Unsecured: There is no collateral required to borrow these loans.
Disadvantages of Short Term Loan
Some of the disadvantages are:
- Strain on Small-Time Borrowers: Small business owners may make defaults in debt servicing as a result of any hike in interest rates or penalties. This will in turn also lower their credit score.
- Lower Borrowing Amount: Short term loans can supplement only small funding requirements i.e. the amount of fund that can be procured using short-term debts is very small.
- Not Suitable For Long Term Projects: Taking such loans for long term projects will not be feasible and can add huge interest cost which may prove costly for an entity. For meeting out any capital expenditure or any large-scale fund requirement, these loans may not be adequate.
Short-term loans are borrowings undertaken by any business entity or an individual for meeting out their short-term fund requirements. These loans need to be repaid within a short period of time usually within a year. Availing such loans have their own benefits and drawbacks. One of the most important advantage is the ease of sanctioning. However, banks and FIs charge higher interest rates on such loans which might increase the cost of borrowed fund.
This is a guide to Short Term Loan. Here we also discuss the definition and how to apply for short term loan online along with advantages and disadvantages. You may also have a look at the following articles to learn more –