Different people have different types of financial requirements, often spread out between both long-term goals and short-term needs. Various loans lent by banks and financial institutions can also be divided based on needs and the tenure of the loan. Loans that run for a short period of time such as 120 days, 6 months, 12 months, etc. are known as short-term loans. Personal loans, consumer loans, bridge loans, and demand loans are a few of the popular types of short-term loans. Similarly, loans for a tenure longer than 3 years are known as long-term loans. Home loans and loans against property fall in this category.
Short-term loans are offered with short repayment periods to both individuals and commercial entities. These types of loans are usually characterised by lower principal amounts, shorter tenures and higher interest rates. Short-term loans are easy to get because the amounts involved are typically small and the eligibility criteria are relaxed. Banks still pay attention to the repayment capacity of the applicant as well as their income and financial stability to approve a short-term loan. Because of the higher interest rates, banks usually prefer to give out these short-term loans as they are decent profit-making instruments.
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Purpose of Short Term Loans
For a company/business: Once the business is established, funds become critical to meet day-to-day expenses and other operational needs. For example, raw materials must be purchased at regular intervals, workers must be paid wages regularly, water and electricity bills have to be paid on time, etc. Moreover, there are other requirements as well. Thus, there is a continuous necessity of capital that needs to be available to meet the operational cost of the company. Short-term loans can provide the funds that are needed to fulfil these requirements.
Short-term loans are mainly taken as working capital funds to meet immediate requirements of the business. Apart from that, they also perform the following functions:
- They facilitate smooth running of business operations by meeting day-to-day financial requirements and allow the business to grow without any hassles and burden arising from the shortage of liquid funds.
- Short-term loans enable firms to hold a stock of raw materials and finished products which further helps in smoothing out fluctuations resulting from a sudden or unexpected rise in the demand. Without such a cushion, a business may lose clients or endure significant losses.
- With the availability of short-term finance, goods can be sold on credit. Seasonal sales are often high during certain periods and buyers may not always be able to handle the expenses immediately. The collection of payment from such debtors takes time. During this time gap, production continues and money will be needed to finance various operations of the business too.
- Short-term loans provide the funds that are required to allow the flow of cash during the operating cycle. Operating cycle refers to the time gap between the commencement of production and the realisation of sales.
- Short-term loans become more fundamentally important when it is necessary to increase the volume of production on a short notice. This often happens in the case of seasonal businesses whose high sales periods are cyclical.
For an individual: There are plenty of situations in which a person needs cash urgently to meet his financial needs. It can be to pay a credit card debt, pay for a medical emergency, purchase a household item or gadget, carry out house repairs, etc. To meet such needs, a short-term loan can be a great alternative to other types of loans. The individual borrower does not have to dip into his investments, savings, or assets making a short-term loan an ideal option.
Features of Short-term Loans
Some of distinct features of short-term loans are discussed here:
- Flexible Loan Amount: For short-term loans, the loan amount usually ranges from Rs 1 lakh to Rs 50 lakhs, though there is wide variation on either side of the margins. Whether you are an individual or a business, you can avail a loan for the amount that you need to meet your current needs.
- Customised Credit Criteria: Most banks understand that your requirements, resources, and objectives are unique to your business. Therefore, they tailor their credit underwriting parameters as per the nature of your enterprise. Customers have the privilege of getting customised credit criteria with short-term loans.
- Minimal Prepayment Charges: Traditional lending institutions whether they are banking or non-banking institutions, charge a fee if you decide to pay off the loan earlier than the pre-decided tenure, often based on the remaining balance. With short-term loans, there are usually have no penalty or prepayment charges for the same, which means that you no longer have to worry about closing your loan obligation ahead of the pre-decided date. Some banks levy nominal prepayment fees when a customer tries to foreclose a loan.
- Picked Loan Tenure: Short-term loans allow you to choose a flexible repayment tenure ranging from 6 months to 36 months according to the nature of the business and cash in-flow or according to the repayment capacity for an individual. The borrower has the option to choose the loan tenure at the time of the loan application.
Types of Short Term Loans
There are a wide range of loans that come under the category of short-term loans. Some of them are listed here:
Installment Loans: While any loan paid back in EMIs can be categorised as an instalment loan, the term is specifically used to refer to the practice of converting a purchase into a loan that is paid back as multiple smaller payments over a period of time. Instalment credit or instalment loan is a popular source of finance for consumer goods like television, refrigerators and also for industrial goods. With typical instalment loans, customers of a bank are given a certain amount of funds as short-term loans. The amount is usually disbursed directly to the merchant. The borrower then makes periodic (usually monthly) repayments until the loan amount including the interest has been repaid in full. Only a small amount of money is paid at the time of delivery of such goods if purchased with an instalment loan. Most electronic gadgets bought from major retailer come with the option of paying in easy Equated Monthly Instalments (EMIs).
The balance is paid in a number of instalments as offered by the retailer or the bank. The creditor charges interest for extending credit. The amount of interest is included while deciding the instalment amount. Auto-debit facility is generally used for salaried customers where the EMI is deducted from their salary account to pay off the balance. Once the loan has been repaid in full, automatic payroll deduction is stopped, the loan account is closed and the relationship between the customer and the financial institution ends.
Trade Loans: Trade loans refer to the credit or funds granted to manufactures and traders by the suppliers of raw material, finished goods, components, etc. Usually business enterprises buy supplies on a thirty to ninety days credit and this is why it is known as trade loans. This means that goods are delivered but payments are not made until the expiry of the period of moratorium of the loan. This type of credit does not make the funds available in cash but it facilitates purchases without making an immediate payment. This is quite a popular source of finance especially for business professionals.
Bank Loans: Bank loans are usually granted by commercial banks as short-term finance to commercial entities. When a certain amount is advanced by a bank and is repayable after a specified period, it is known as a bank loan. Such an advance is credited to a separate loan account and the borrower has to pay interest on the whole amount of loan irrespective of the amount actually drawn. Usually, such loans involve the security of assets. Bank loans are usually granted by way of loans such as cash credit, credit card, overdraft, discounted bills, and more.
- Loan issued on Credit Card: A credit card is a payment card issued to users as a method to pay bills or make purchases. It allows the cardholder to pay for goods and services based on the holder’s promise to pay for them later. However, a credit card has become a lot more than just a payment card. Banks have also started issuing loans on the credit card based on the credit history of the borrower. These are primarily short-term loans which are meant for small businesses. This a convenient option as the customer then need not calculate a balance remaining before every transaction, provided the total charges do not exceed the maximum credit line for the card.
- Overdraft: When a bank allows its depositors or account holders to withdraw money in excess of the balance in his account up to a specified limit, it is known as an overdraft facility. In other words, bank overdraft is an extension of credit whereby the fees charged on customers’ transactions are covered by financial institutions because the customers’ checking account lacks sufficient funds. The overdraft limit is granted based purely on the creditworthiness and past credit history of the customer. The rate of interest in the case of overdraft is usually less than the rate charged under other types of short-term bank loans.
- Discounting of Bill: Banks also advance money by discounting bills of exchange and promissory notes. The bills are signed by the payee and converted into cash by the bank. When these documents are presented before the bank for discounting, banks credit the amount to customer’s account after deducting the discount from it. The amount of the discount is equal to the amount of interest for the period of the bill.
- Customer’s Advance: Sometimes businessmen insist that their customers make some advance payment. This advance payment is generally asked for when the value of the order is quite large or things ordered are quite expensive. Customers advance payment represents a part of the payment towards the price on the product which will be delivered at a later date. Customers generally agree to make advances when such goods are not easily available in the market or there is an urgent need of goods or they do not want to lose it to some other customer. A firm can meet its short-term requirements with the help of the advance paid by customers.
Loans from Co-operative Banks: Short-term loans can also be availed from the co-operative banks as they are a good source to procure short-term funding. Such banks have been established at local, district and state levels. The State Cooperative Bank finances and controls the District Cooperative Banks in a state. They are also governed by Reserve Bank of India regulations. Besides offering short-term loans such as agriculture loans and crop loans to farmers, these banks also grant loans to individuals as well as commercial enterprises. Membership of the bank is an important eligibility condition for securing a loan from the bank. The functioning of these banks is largely comparable to the functioning of a commercial bank.
Benefits of Short Term Loans
Banks and Non-Banking Financial Companies (NBFCs) have been giving out short-term loans for a long time because of their popularity, benefits, and obvious practical use. A few of the main benefits of short-term loans are listed here.
- Quick Approval Process: You can get short-term finances from most banks within 3 working days of loan application if your documentation is in order. In today’s fast-paced world, timely access to funds has the power to unlock potential business opportunities and meet any urgent financial needs. Therefore, to give you short-term loans, the bank only has to check your creditworthiness. The process is fairly quick making it one of the best loan products to access money quickly.
- Cost-efficient: Short-term loans are usually given out at relatively high interest rates. However, since people only apply for a short-term loan when they need the money urgently, it turns out to be a cost-efficient option. In addition, this loan lasts for a short duration of time and thus, the total amount of interest paid by the borrower may turn out to be far less as compared to a loan for a similar amount for a longer tenure.
- Serves Long-term Purposes: Short-term loans are usually meant to serve immediate goals and expenses. However, short-term loans are also capable of serving long-term purposes. For instance, cash credit is granted for one year but it can be extended up to 3 years (or more with some banks) with its annual review model. Thus, sources of short-term finance may sometimes provide funds for long-term needs as well.
- Fewer Restrictions: The regulations and requirements for a short-term loan are lenient compared to those of a long-term loan such a home loan. The borrower can use the loan amount in any way he desires since the bank does not limit how the funds are utilized on most short-term loans. There are exceptions such as in the case of consumer loans which are disbursed directly to the merchant.
- Soft Credit Check: Many banks and financial institutions giving out short-term loans only carry out a background check of their relationship with the bank. For long-term loans, they will check the credit history. Apart from the repayment capacity, monthly income is also not checked in detail when considering the application for a short-term loan. As long as there are no red flags, an applicant with a good repayment history is generally approved.
