When to Choose Short-Term or Long-Term Loans

Posted at 05:14h in Small Business Financing by Kelly Hillock

When choosing short-term or long-term loans, consider how fast you need the money, how much you need, and what your cash flow will be over the life of the loan. Short-term business loans have quicker approvals for smaller loan amounts compared to long-term loans, and they are ideal when speed is your priority.

The faster turnaround and shorter payback periods with short-term loans come at a higher interest rate versus long-term loans, but you can also pay less in total interest since the payback period is shorter.

Long-term loans have a longer approval process, but they provide larger amounts of capital and come with lower interest rates than short-term loans. This makes them preferable for larger investments and when keeping monthly payments low is important.

Here’s a quick overview comparing the advantages of both options, but each lender has their own policies so they could differ when you apply.

	Short-Term Loans	Long-Term Loans
Interest Rates	High	Low
Payback Periods	Short	Long
Loan Amounts	$5,000 – $500,000	$500,000+
Approval Times	1 Business Day	Up to 90 days for some including SBA
Credit Score Recovery	Faster	Slower
Monthly Payments	Higher	Lower
Flexibility of Funding Uses	High Flexibility	High Flexibility

Sometimes the choice of short versus long term is an easy one to make, like choosing an emergency loan for immediate cash after a disaster or a commercial and industrial loan to build a major new facility.

Knowing when to go with short or long-term loans doesn’t have to be a difficult decision, once you map the benefits out and match them to your situation. Here’s a few scenarios where both short and long-term business loans can make sense and how to decide what is right for you.

Equipment needs

Both short and long-term loans can help when something goes wrong with machines in a factory, delivery vehicles in your fleet, or computers in your office. Choosing the right term length comes down to weighing the costs of the loan in terms of interest payments and monthly payments versus the opportunity cost of the equipment being out of service.

When short-term loans are better

Short-term loans are your choice over long-term loans when broken equipment will cost you sales and potentially long-term customer satisfaction. The faster approvals get you the financing you need to keep machines operating at full speed.

Despite the higher rates with short-term loans, you might pay less in total interest because the payback period is shorter. Instead of focusing on the higher rate when making your decision, compare the total interest cost of the loan versus what you would lose in sales and long-term customer value without the equipment getting fixed.

A short-term loan may also be a better option than long-term loans to buy new equipment when compared to a long-term loan when you have the cash flow to cover higher monthly payments. The shorter term will make your total cost lower (total cost = purchase price + total interest). Plus, a section Section 179 deduction and bonus depreciation allow you to make deductions for a lower tax bill to offset the higher monthly loan payments.

When long-term loans are better

If you’re planning on expanding your business and need to purchase new computers and servers, or buy machinery and equipment for future use because it is now on sale, long-term loans are better than short-term loans because the lower monthly payments give you more cash flow as you work toward growing.

Real estate purchases

When choosing between the two for land purchases, it comes down to how long you have until the investment becomes profitable and the speed at which you need to act.

When short-term loans are better

When buying a property available at auction after foreclosure or securing a lease that has just opened up, speed is essential to avoid losing out to someone else. The faster approval process of a short-term loan can help you secure the deal and you can always refinance later or take a long-term loan that pays off the bridge loan and reduces your monthly expenses. You can also try a short-term bridge loan to secure the deal and then refinance it into a long-term loan for the lower monthly payments.

When to choose a long-term loan

For corporate real estate purchases and large-scale properties that will take a long time to become profitable, the long-term business loan will be better than short term as you’ll need to keep cash flow open. The lower monthly costs allow flexibility for construction, which could include office buildings or strip malls, or if you plan on sitting on the property as an investment since there won’t be any revenue in the near future.

Pro-tip: Try recasting your long-term loans if you’ve been making payments on time each month. Recasting lets you pay off the lower principal vs. the original loan amount, reducing your monthly payments.

Cash flow gaps and expansion opportunities

Excess cash flow is a blessing, but disasters can happen where you need financing to keep operations moving, or maybe an opportunity for growth comes along and eats up your reserves. Other times, there may be market downturns where you’ll need the financing to keep your business going. Both types of loans can make sense, but certain situations make one better than the other.

When short-term loans are better

Short-term loans are better than long term for cash flow gaps like:

Making payroll on time while waiting for customer payments

Chasing inventory for popular or seasonal products

Dealing with unexpected expenses

If a busy season is approaching and you have to make payroll while you train new team members or stock up on inventory, short-term payroll loans are better than long term. You’ll get the funding you need to pay the staff, and you’ll have the cash flow to pay the loan back once the busy season is over.

The same applies to increasing inventory if there is a larger-than-expected demand during the season. The speed of getting approved for inventory financing lets you strike when the opportunity is hot vs. missing out on the sales.

Short-term loans like daily payment loans are a great option to cover unexpected expenses when your business has steady sales since you get a quick, lump-sum of cash from the loan and then pay it off from a portion of sales each day.

As an added bonus, the quick repayment periods for these short-term loans may give a boost to your credit score because the debt clears quickly and helps offset any temporary drop from the initial application.

When long-term loans are better

Long-term loans are a better choice than short-term business loans when filling your cash flow gap requires a strategic shift in your business and you need to come up with new products or find new markets for future growth. The lower monthly payments allow for you to continue investing without draining more of your cash flow compared to the higher payments of a short-term loan. This puts less stress on your business, allowing for the development to proceed at a stable pace.

The same goes when you’re investing in research and development. There’s no telling how long it will take before a breakthrough happens, and you still need to get patents, find ways to produce or replicate, and get the legal documentation. The lower monthly payments come in handy here as there’s no telling how long the processes will take while they also eat into your cash flow.

If you need funding quickly and are able to pay it back fast, short-term business loans are better than long term. If there is market uncertainty or you’re investing in long-term growth, long-term business loans will be better than short-term business loans as they come with lower monthly payments and you can get larger amounts of funding if you don’t mind the slower approval times.