Not every small business loan is alike. There is a clear difference between short-term loans for small business owners, which you can get from online and other alternative lenders, and long-term loans, which you typically take out from a traditional lender.
But when someone pictures taking out a loan in general, they often imagine a long, drawn-out process, with lots of paperwork to file. If you hold this misconception, you’re not alone.
Here are four common myths around short-term business loans. We debunked them, so you can make an informed decision on the best way to fund your business.
Myth 1 – Applying for a Loan Is a Long, Complicated Process
For a traditional small business loan, this can definitely be true. You need to complete a lengthy application with all kinds of supporting documents like financial statements, years of tax returns and a business plan showing how you will use the money.
Not only do you need to spend time putting this together, but traditional lenders could also take weeks or even months to decide. This is time your business might not have to spare.
With short-term lenders, the process is much faster. Some lenders approve loans on the same day of receiving your application. They also require a lot less information; you may just need to provide three months of bank statements verifying your business income — no business plan or financial statements necessary.
Myth 2 – You Need a Perfect Credit Score and Supporting Docs to Qualify
When the financial crisis hit in 2008, traditional lenders tightened up their lending standards and made it more difficult for small businesses to take out a loan. Even though the economy is a lot better, it can still be challenging to qualify, especially if you’ve only been in business for a few years, or experienced credit problems in the past.
Short-term loans for small business owners do not have the same requirements. There are lenders that will define your small business by its potential, rather than by a number. They will consider your application despite a low business credit score or lack of collateral, so long as you can provide proof of recent business revenue.
Myth 3 – A Loan Only Makes Sense for Long-Term Investments
Traditional loans are typically designed to last several years. It’s the only time frame that makes sense given the lengthy application process. In fact, if you pay off your loan early, traditional lenders likely will charge a prepayment penalty to make up for all the interest they should have charged you. In this case, the loans only make sense for a long-term investment that will take years to pay off.
But a short-term loan can be set up to last a year or less. Some do not have a prepayment penalty. You can borrow quickly and repay just as fast, even within a few days, without owing anything extra. As a result, you have the flexibility to finance short-term needs.
For example, if a client is a few days late on paying an invoice, you can borrow to cover any cash flow concerns until they catch up on payment. Or if you forecast a slow business stretch on the horizon, you can borrow now and repay as soon as sales pick up.
Myth 4 – Short-Term Loans Are “Too Costly”
This mode of thought is subjective and really depends on the situation. Short-term small business loans do tend to have a higher interest rate than traditional loans, that’s true. But they also avoid many of the other fees. Short-term lenders usually do not charge an origination fee, which is something traditional lenders charge to launch a loan. This could be one percent or more of the amount you borrow. If you borrow $100,000, that’s a $1,000 extra charge on top of the interest.
Traditional loans also last longer so you’ll be paying interest over a longer amount of time (or pay early and owe a prepayment penalty as mentioned). Depending on how you manage the loan, you might pay less with the short-term arrangement even with a higher interest rate.
You also should weigh the borrowing costs against the consequences of not having cash on hand. There is a cost to not borrowing money, the cost of doing nothing. If you miss payroll, that could lead to employee turnover. You could potentially lose a huge sale if you don’t have the appropriate inventory in stock, or damage a vendor relationship by missing a bill.
In all these situations, the costs of not having cash can be far greater than what you would pay in interest for a short-term loan.
New financing sources can be intimidating when they’re shrouded in common misconceptions, but the more you learn about them, the easier it will be to decide if they fit your business needs.