One of the main factors to consider while taking a loan is its term length. Depending on the reason for taking a loan, you can either opt for a short-term loan or a long-term one.
The loan tenure determines the monthly repayment amount, as well as the rate of interest applicable. That is why it’s important to ensure you gain a better understanding of each type of loan term to determine which one suits your requirements best.
Short term loan
A short term loan has a validity duration of two-three years. A common variant is the payday loan, which is given to help you meet your immediate financial needs till your next payday.
These kind of loans come with minimal approval requirements and the loan amount gets credited to you at the same day. Short-term loans are usually attractive for most business owners that don’t need long-term financing for their small or medium-size business. The flexibility and quick turnaround of these loans help to keep their business running smoothly.
Additionally, short-term loans are a nice solution for business owners to overcome financial setbacks and get liquidity, as opposed to acquiring a larger long-term debt.
Long term loan
A long-term loan has a validity of more than three years. Sometimes, it involves multiyear repayment terms lasting for decades.
These type of loans can be secured or unsecured- the latter means that the loan comes without security in the form of an asset or a collateral, such as your home or your car. A secured loan is just the opposite, but it does include higher interest rates as it’s riskier for the lender.
Understanding the features of both these loans is the key to determining which type is best suited to your present requirements. Consider the following points:
A long-term loan involves a lower interest rate than that of a short-term loan. Since a long-term loan covers a longer span of time, the processing fees and interest rate are automatically lower.
By the same logic, a short-term loan has a higher interest rate as the time given for repayment is shorter. So bottomline, if you want some cash infusion to meet an immediate need, or maybe build your business inventory for busier times, it may be wiser to opt for a short-term loan.
Short-term loans are acquired for immediate requirement, including payment for purchases, requirements to meet working capital needs, emergency expenditures and so on. These loans are relatively easier to obtain.
On the other hand, long-term loans are typically obtained for a more distant goal, such as building of new infrastructure, purchase of new plots, purchase of machinery or business expansion in a new geographical location. These loans take time to be approved, as not everyone qualifies for them. As such, they are difficult to obtain.
The eligibility criteria vary for both these loans. While short-term loans are easier to obtain due to the quick application process and limited documentation, long-term loans are approved only after thorough checking of credit worthiness.
To qualify for a long-term loan, you have to show pertinent details relating to income, credit rating, profitability of your business, as well as projected statements demonstrating the bright prospects of your business.
It’s possible to apply for short term loans with limited paperwork. This typically includes your identity proof, address proof, income proof and ITR returns. However, with long-term loans, the documentation process is extensive and a lot of paperwork regarding the owner and their business are mandatory to be submitted.
#5 Debt Trap Risk
A short-term loan comes with a high risk of debt trap. Due to the easy availability of finance, and high interest rate, the borrower may never manage to pay off the loan entirely, and they may also end up shelling out a huge amount of interest. On the contrary, the debt trap risk is lower in a long-term loan, as you have enough time to repay it off.
#6 Processing time
Processing of short-term loans requires limited time. On the other hand, a long-term loan incurs thorough verification and processing, which consumes time and involves additional effort. Owing to the long tenure of these loans, it’s important for the bank/lender to inspect the documents thoroughly before giving an approval.
A short-term loan can even be pre-approved, but this may not be possible for long-term loans. Another important fact to note is that short-term loans carry a significant prepayment penalty due to their short tenure. However, there is no such penalty for a long-term one.
Which One is Better?
Basically, the type of funding you need depends on your personal or business requirements. There are advantages and disadvantages of both these types of loans and it’s important to understand the present situation, future risks, as well as financial status, in order to choose the best fit. Also, it’s important to make sure that the loan bolsters your business, or your personal loan need in every manner possible.