As a modern business owner, deciding what length of term to target when securing financing for your business is important since it can have a significant effect on your monthly budgeting. There are loans that can be taken out for longer terms, typically five years and up, and shorter term loans that can last less than a year. Deciding which of these options fits the short and long range needs of your company best involves looking at the pros and cons that each offer and deciding which apply most to your current situation.
Long-term financing solutions are loans that generally have a loan term above five years, and can sometimes last two decades or more depending on the circumstances. Financing of this sort typically comes from companies that have access to a rich capital base, which lets them make investments that mature over several years or even decades. Smaller financing companies generally won’t want to stretch the loan term out for these longer periods because it takes them longer to recoup the principal back.
In some cases, longer term loans will come with a comparatively lower interest rate, particularly if the loan is secured with some form of capital to help mitigate risk for the lender. If the loan is unsecured however a longer term loan may have a higher interest rate to compensate the lender for having to wait longer to be paid back. The longer a loan term is stretched out the lower the monthly payment is, so this often presents an incentive to borrowers to seek a longer term. A lower monthly payment on the books makes it easier to qualify for other financing as well, particularly if the business’ monthly debt to income ratio is taken into account on other applications.
Longer term loans are also quite popular when they come with no pre-payment penalty. A pre-payment penalty is a charge a borrower incurs when they pay too much extra above their regular payments to the loan principal. This charge dissuades borrowers from paying off the loan sooner which would otherwise save them on interest charges and prevent the lender from collecting that interest. The absence of a pre-payment penalty allows the borrower to pay off the loan as soon as they like – so a longer term loan would then give them the dual flexibility of a lower required monthly payment as well as the ability to pay of the loan early to save on interest if they are so inclined.
Stretching financing over a longer period can ultimately lead to paying back more interest in the long haul, so it’s important to consider how this fits into your company’s long term plan. It can be tempting to choose a longer term even if it comes with a higher interest rate on an unsecured loan in order to secure the minimum payment, but it may be strategically better for the long term health of your company to pay off the loan sooner. Some business owners take a longer term loan with no prepayment penalty believing they’ll be disciplined enough to pay off the loan sooner.
Long-term loans are usually utilized in objectives that are also spread over a long period of planning and projection. This may include acquiring new property, expanding the company through new facilities, etc.
Short-term financing is can be used by any company but it is particularly popular with smaller and medium sized businesses. Interest rates on these loans vary depending on the requirements to qualify.
For instance some loans are geared towards companies with credit challenges or companies that have difficulty meeting over requirements for traditional lending and therefore need to seek out alternative loan options. Loans such as these will typically have interest rates and costs higher than lending products with more conservative guidelines.
Many short term loans are designed to have a very fast processing time to get money to borrowers quickly. These loans also often come with no prepayment penalty so they can be paid off sooner. Being able to secure a short term loan with no prepayment penalty is very beneficial – if the interest rate is high, the borrower can strive to pay it off quickly and thereby feel that negative effects of that higher interest rate less.
As mentioned short term loans can come with a higher interest rate, and many of them don’t report their payment histories to the credit bureaus, so borrowers in these cases wouldn’t reap the benefits of positive payment history on their credit score for future applications.