Is a mid-term business loan more flexible than an SBA business loan?
As you research small business loans, you might come across a few financing methods that you didn’t even know existed. In the midst of all that novelty, though, you’ll find at least one familiar phrase: term loans. Term loans are common in business financing.
Term loans are a lump sum of cash that a lender deposits right into an approved borrower’s business bank account. Borrowers repay that amount, plus interest, over a predetermined amount of time.
What you might not know is that there are variations on this theme—namely, long-term and short-term loans. (And there are variations within those variations, which we’ll get into here, too.) Long-term and short-term loans vary according to the length of their terms, of course, but there are a bunch of less obvious differences between them as well: Their eligibility requirements, loan amounts, and interest rates can vary dramatically, too.
While one may seem more desirable than the other, in reality, the type of loan you’re dreaming about might not be the best fit for your business at the moment. You’re probably banking on a high-capital, low-interest, long-term loan, but a short-term loan might be the more affordable, more accessible, or simply the more appropriate form of financing for your business. That’s especially if you’re a newer company that doesn’t have several years’ worth of profitability and general financial stability that risk-averse, long-term lenders need to see from their borrowers.
On the other hand, maybe you do have the stats and bandwidth for a long-term loan. Either way, the decision can have a big impact on your bottom line. Here’s what you need to know about long-term and short-term loans.
How Long-Term and Short-Term Loans Differ
The clearest differentiation between long-term and short-term loans is the length of their respective repayment periods. Short-term loans are pretty cut and dry: They’re any loans that you’ll need to repay within 3 to 18 months—but usually less than a year. As you can imagine, long-term loans are intended to be paid off during a longer amount of time.
The usual repayment period for long-term business loans is a little trickier to define, though. Generally, a long-term loan can be defined as any loan that takes 24-plus months to pay off, but that “plus” gets pretty liberal. It all depends on the lender you work with, your business’s financials, your intended use of funds, and, possibly the loan program you’re participating in.
Getting a Little More Granular with Long-Term Loan Definitions
Let’s talk a little more about what we mean with regard to term length. In business lending, a “long-term loan” can actually refer to a few different financing products. For today’s purposes, we’ll cover three main types of long-term loans:
Both banks and online lenders can offer medium-term loans. Either way, you’re generally looking at a 2 to 5 year repayment period.
Long-Term Bank Loans
In truth, it’s pretty tough to get a business loan from the biggest banks—and tough to secure a loan from your local bank, too. But if you’ve been in business for a few years, have a strong credit profile, and solid revenue numbers, you’ll have more luck with institutional lenders. Long-term bank loan repayment periods typically last 5 to 10 years (even longer if you’re purchasing commercial real estate).
The money involved in SBA loans doesn’t actually come from the Small Business Administration (SBA’s) own vaults—rather, participating lenders issue SBA loans, but the government agency guarantees their repayment. In most cases, the SBA guarantees 75% to 85% of a loan if the borrower defaults, but the exact percentage varies according to the loan program and loan size. SBA-approved lenders are most often banks or credit unions, but qualifying alternative lenders and non-profit corporations can partner up with the SBA, too.
The government’s guarantee makes SBA loans among the most highly coveted small business loans available.
The SBA offers a few loan programs, all of which are designed for different use cases. SBA 7(a) loans are the most popular, since you can use these funds for the widest range of purposes—working capital, buying real estate, purchasing equipment, refinancing debt, acquiring an existing business, you name it. The SBA has a long list of allowable uses for 7(a) loans.
Repayment periods on SBA 7(a) loans vary according to the borrower’s intended use of funds, too: Up to 7 years for working capital, 10 years for equipment, or 25 years for real estate.
→TL;DR (Too Long; Didn’t Read): Short-term loans carry repayment periods between 3 and 18 months. Long-term loans need to be repaid in 2+ years, but the exact length of their terms depends upon the type of loan program, the lender offering that loan, and the borrower’s business loan application.
Three More Differences Between Long-Term and Short-Term Loans
Other than their repayment periods, there are a few more crucial differences between long-term and short-term loans you need to know.
Historically, only the most qualified borrowers have been eligible for long-term loans. That’s because lenders face a greater risk of nonpayment when extending a long-term loan compared to a short-term loan.
When lenders extend large amounts of capital over a long period of time, they need to be absolutely certain that they’re working with borrowers who will repay what they owe in full and on time. Typically, that translates into established businesses, with many years of profitability, owned by individuals with high credit scores. Clearly, only a select few businesses can live up to those requirements.
In the wake of the 2008 recession, that exclusivity gave rise to alternative, online lenders. These platforms strive to make loans more accessible to the borrowers whom banks deemed unqualified for long-term loans. The short-term loans that these lenders specialize in have less stringent requirements than bank loans.
Unfortunately, it’s hard to give you the exact requirements you’ll need in order to be eligible for any type of loan, including short-term and long-term loans. Ultimately, it’s up to your lender to decide whether you’re eligible for their loan or not, plus the terms and cost of your loan.
That said, you might find success with the following stats, which you can think of as general guidelines:
12+ months in business
500+ credit score
$100,000+ in annual revenue
1+ years in business
650+ credit score
$200,000+ in annual revenue
Long-Term Bank Loan
2+ years in business
700+ credit score
$200,000+ annual revenue (some banks require profitability)
2+ years in business
700+ credit score
$500,000+ annual revenue (some banks require profitability YOY)
…and that’s in addition to a slew of SBA loan requirements, too.
Also, long-term loans often require the borrower to put up collateral—could be equipment, real estate, cash, or a blanket lien, among many other types—which the lender can seize and liquidate to recoup a defaulted loan. Again, high capital amounts = high risk = serious precautions on the lender’s end. Short-term loans, on the other hand, don’t usually require collateral.
Again, the only way to know for sure whether your business is eligible for any type of loan is either by working with a loan specialist or by walking into your local bank, depending on the type of loan you’re going for. But these figures can help you gauge whether a short- or long-term loan is within reach for your business.
→TL;DR: Lenders only offer long-term loans to the lowest-risk borrowers, so eligibility requirements for long-term loans are stringent. Short-term loans are typically easier to qualify for.
As you know, long-term loans offer borrowers larger loan amounts than short-term loans do.
Once again, the exact amount of capital that a lender will offer an approved borrower depends upon the information provided on the borrower’s business loan application. Loan amounts depend upon the lender itself, and the type of loan offered, too; that’s especially the case with online lenders, who all assign different caps on their loan products.
Short-Term Loans: $2,500 to $250,000. The average short-term loan amount is $20,000.
Medium-Term Loans: $25,000 to $500,000, with an average loan amount of $110,000.
Long-Term Bank Loans: $100,000 to $500,000.
SBA 7(a) loan: Up to $5 million, but the average SBA loan amount was $417,316 in 2016.
You’re probably starting to see a theme here: As loan terms lengthen, the potential loan amounts increase, and the eligibility requirements toughen up, too. This all loops back to that foundational concept: As the lender’s risk of extending a loan increases, they’ll take greater care to protect their interests in case the borrower defaults.
→TL;DR: Long-term loans usually offer higher capital amounts than short-term loans.
Of course, loans never come for free—you’ll have to pay back the lump sum (also known as the principal), in addition to the interest rate your lender assigns you, plus any additional loan fees your lender charges.
Like all things small business loan-related, the cost of any given loan isn’t formulaic, because every loan type and underwriting process is different. But we’ll show you what to expect, generally, about the costs of long-term and short-term loans.
Short-Term Loan Cost
Short-term loans are typically easier for businesses to qualify for than long-term loans. Compared to banks, these alternative lenders are more inclusive of which borrowers they approve for their loans.
But without a tough set of requirements to weed out risky borrowers, short-term lenders need another way to protect their interests in case a borrower defaults. For this reason, short-term loans typically come with higher interest rates than long-term loans. The additional cost ensures that short-term lenders make money off their loans, even if a borrower defaults.
You’re paying for the speed of your loan, too: Funds from short-term loans can be delivered into a borrower’s bank account in as little as one day.
Lenders also assign higher interest rates to the borrowers whom they deem extra-risky, like businesses with lower annual revenue, and business owners with lower personal credit scores.
So, the cost of your short-term loan depends in large part on how the lender evaluates the information on your business loan application. Generally, though, you can expect annual percentage rates (APRs) on short-term loans to vary from 8.5% to as much as 80% or more. APR includes the cost of interest plus additional fees attached to your loan, so it’s a more accurate representation of your loan’s annual cost.
This deserves a caveat: Even though short-term loans usually have a higher interest, they are not necessarily costlier than long-term loans. In fact, quite the opposite is often true. The longer you hold onto a loan, the more money you will pay in total interest over the life of the loan. So it’s often the case that a 10-year long-term loan will be costlier over the life of the loan than a 6-month short-term loan, even though the long-term loan has a lower quoted interest rate.
Calculating your cost of debt, including fees, is the only way to know for sure whether a loan is “worth it” and will help your business grow.
Medium-Term Loan Cost
Generally speaking, you can expect a medium-term loan to carry an APR between 7 and 30%. Unlike short-term loans, most medium-term loans amortize. Although you’ll repay the same amount every month (or every week, depending on your repayment schedule), that payment comprises two facets: the principal and the interest.
As you pay down your loan, your payment gets allocated to differing amounts of interest and principal. Often, lenders stack the earliest bills with interest so they can make their money back ASAP, and the interest amount gradually decreases over time. That means you’ll save on interest if you’re able to pay off an amortized loan early.
Long-Term Bank Loan Cost
Depending on the terms of your long-term bank loan, your interest rates may be fixed or variable. Either way, those APRs will be among the lowest you’ll find, starting at around 5%. Banks value customer relationships, too, so they might reward loyal customers with lower interest rates.
SBA Loan Cost
SBA loan interest rates are based on market interest rates, but for most loan programs, the SBA sets a maximum rate that intermediary lenders may charge borrowers. Exact rates depend upon the loan program, the size of the loan, and terms of the loan. Currently, rates on the SBA 7(a) program start at around 7%. Depending on the size and terms of your loan, you might also need to pay an SBA guarantee fee.
→TL;DR: Short-term loans usually carry higher interest rates than long-term loans. That said, you’ll typically pay less in total interest on a short-term loan because you’re holding the loan for a shorter period of time.
Is a Long-Term or Short-Term Loan Right for You?
Ask a borrower which type of small business loan they want, and you’re likely to hear a long-term loan. Typically, long-term loans are considered more desirable than short-term loans: You’ll get a larger loan amount, a lower interest rate, and more time to pay off your loan than its short-term counterpart.
But desirability comes with an element of exclusivity—long-term loans are tougher to qualify for than short-term loans.
And, ultimately, your business just might not need the amount of capital you can get with a long-term loan. Or, more realistically, you might not be capable of repaying a loan amount that large—although interest rates on short-term loans tend to be higher than those attached to long-term loans, you’ll actually end up paying more interest on a long-term loan, since that interest has more time to accrue. (To understand the true cost of your loan, either short- or long-term, you’ll need to calculate the cost of debt.)
Time to funding can differ, too. If you’re in a time crunch, a short-term loan from an online lender might be the better option for you. Long-term loans, on the other hand (especially SBA loans), might take three weeks or more to land in your bank account, as opposed to the day or two it can take to see funds from a short-term loan.
At the end of the day, the best small business loan is the loan that truly helps your business grow. Whether that’s a long-term or short-term loan is up to you and your lender.
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