Long-Term Business Loans vs. Short-Term Loans: Understanding the Difference
A long-term loan — often referred to as a term loan — can provide the money needed to make a major investment in your business. Typically granted for periods of three to 10 years, this type of small business loan can fuel business growth by financing major upfront costs, such as the purchase of equipment or a facility renovation. Get educated on long-term loans, so you can choose the right one for your business.
How long-term loans work
An investment in future growth, long-term loans are tailored to fit each individual business. Most are used to finance the purchase of a specific need — i.e., vehicles or machinery — that will help the company become more profitable. Term length typically ranges from three to 10 years, but can extend past 20 years in some cases. The useful life of the investment should be the guiding point that determines the loan term because it wouldn’t be wise to continue making payments on an asset no longer in use.
Existing collateral is typically required to obtain a long-term loan. This means if the loan goes into default, the lender would be able to take possession of and sell assets owned by the company to recoup expenses. In addition to collateral, lenders also usually require companies to have a business history that spans at least two years, as well as a strong credit score.
When a long-term loan application is approved, the business receives the funding upfront as a lump sum. Payments are usually made in monthly installments — sometimes quarterly — with an agreed-upon interest rate tacked onto the principal.
The difference between long- and short-term loans
“Generally speaking, short-term loans are more for working capital or receivable financing,” said Dianna Seaborn, director of the Office of Financial Assistance at the U.S. Small Business Administration. She said longer-term loans give the business more time to repay and manage its cash flow.
Before completing an application, it’s important to learn as much as possible about short- and long-term business loans, to make the best choice for your business. Here’s a breakdown of the main differences between the two loan types.
The most obvious difference between long- and short-term loans is the amount of time you have to pay them back. Long-term loans typically carry a repayment period of three to 10 years, with the ability to go beyond 20 years in some cases. On the other hand, short-term loans usually need to be paid back in full between three to 18 months from issuance.
Long-term loans are easy to fit into your budget because they have a fixed interest rate and a set monthly payment. Short-term loans can be a bit more challenging because some lenders require payment on a daily or weekly basis, in addition to charging higher interest rates.
Long-term loans can be difficult to obtain. There’s a lot of paperwork involved and businesses are typically required to have a solid credit score, existing collateral and an operating history that spans at least two years. On the contrary, short-term loans are much easier to obtain. Minimal paperwork is involved and some lenders will consider applicants with bad credit.
The annual percentage rate attached to long-term loans is typically very low, making them a cost-effective financing solution. Deemed much riskier, short-term loans typically have much higher interest rates, because the convenience of fast cash doesn’t come cheap. Generally speaking, the greater the risk the lender deems a business, the higher the rate.
Time to funding
Since long-term loans require a lot of paperwork, they have an extended documentation processing time. Consequently, they take quite a while to fund. This is the exact opposite of short-term loans, as minimal paperwork and a fast approval process means the time-to-funding can be as quick as 24 to 48 hours.
The objective of the two loan types is revealed in their names. Long-term loans are used to make an investment in the future growth of the business — i.e., to purchase equipment. Short-term loans can be used to expand operations, but businesses generally opt for this type of financing when cash is needed immediately to avoid a disruption in operations — i.e., to fund payroll until a major client’s check comes in.
Rates and repayment terms on long-term loans
Long-term loan rates fluctuate by lender. Factors such as your credit score, collateral required, loan term and economic conditions play a role in the rate you’ll be offered.
Other expenses associated with your long-term loan will vary by lender, but will likely include closing costs and processing fees. Read the fine print carefully before signing the contract to make sure you’re not hit with any hidden fees.
“You need to be aware of what that cost is and understand whether or not you can afford that,” Seaborn said.
The SBA can help if you’re nervous about going through the loan process on your own. The agency’s website offers a wealth of information to help small business owners like you make the best possible decisions.
“Understand your business and what it can afford to pay,” Seaborn said. “Don’t be afraid to ask for that advice.”
The SBA co-sponsors Small Business Development Centers throughout the U.S. — there’s at least one in every state, including Washington, D.C., Columbia, Guam, Puerto Rico, American Samoa and the U.S. Virgin Islands. Seaborn said the counsel of an SBDC allows you to work through your business plan with an objective third party to help you decide the next steps.
SBDCs are hosted by universities and state development agencies and partially funded by the SBA. A variety of free business consulting services are available in addition to low-cost training services. If you need assistance, visit the agency’s website to find an SBDC in your local area.
Applying for long-term loans
The approval process for a long-term business loan can be rigorous, so it’s important to be fully prepared before starting your application. Here are a few steps to take before completing an application to increase your chances of approval.
Decide how much money you need to borrow: You have big plans for your long-term loan, but you might not know exactly how much it will take to fund your initiative. Calculate a solid estimate now, so you don’t run short on cash or end up having to pay interest on extra money you didn’t actually need.
When you have a number in place, use the LendingTree business loan calculator to get an idea of your monthly payment. Simply enter the loan amount, expected interest rate and the loan term you have in mind to see if it fits your budget.
Create a business plan: According to the SBA, having a solid business plan in place, among other things, will increase your chances of securing a long-term loan. If you don’t have a business plan or need to refine your existing one, the SBA offers a free 30-minute online class. You’ll learn why you need a business plan, the different components of a robust plan and gain access to sample business plans and other resources to help you craft one of your own.
Gather key documents: Since long-term loans come with a lot of paperwork, you need to be ready to provide the necessary information. In addition to your business plan, lenders will need your Employer Identification Number, filing of legal structure, recent tax returns, business license, profit and loss (P&L) statements and balance sheet. Having these items on hand will allow you to complete the process faster.
Check your credit score: When applying for a long-term loan, your business isn’t the only thing under scrutiny. As the owner, lenders will also run a credit check on you. Visit AnnualCreditReport.com — the site authorized by law to provide you with free reports from Equifax, Experian and TransUnion — to make sure your credit report is accurate, so you’re presented in the most favorable manner possible.
The bottom line
A long-term loan can help take your business to the next level, but knowing what you’re getting into is crucial. Before making a decision, carefully consider all financing offers to make sure you’re making the best choice. Doing your homework will allow you to feel confident in your decision and ability to comply with the loan terms.