Financial Management has become a part of individuals, businesses, companies, institutions, and government’s points of concern in their everyday operations. This is a result of these sectors’ increasing trend of financial needs.
Further, prioritizing their financial needs is also a significant contributor to the efficient use of their financial resources. That withstanding, growth and development are simultaneously necessary to ensure continued competitive advantage in their activities.
Moreover, their current income or available funds are, in most cases, deficient in meeting their financial requirements in totality. Therefore, they are caught up at crossroads of what to complete, when to do it, and with what resources.
Hence, triggering the need for financial borrowing to broaden their financial muscle capacity. This borrowing is in the form of loans from financial institutions.
There are different types of loans, and our focus is on Short Term and Long Term loans.
Key Takeaways
- Short-term loans are loans with a repayment period of up to one year, while long-term loans have repayment periods extending beyond one year, often spanning several years or even decades.
- Short-term loans are used for temporary cash flow needs, such as working capital or emergency expenses. In contrast, long-term loans are used for larger investments or long-term projects, such as business expansion or purchasing a home.
- Interest rates for short-term loans are higher than long-term loans due to the increased risk associated with shorter repayment periods.
Short vs Long Term Loans
The difference between Short Term and Long Term loans is the amount of time required to repay the funds borrowed.
This means Short Term Loans are issued and repaid within a short time frame, within one year, while Long Term Loans, upon borrowing, are paid back over the years. The period varies from over one year up to even 30 years, depending on the type of loan.
Comparison Table
| Parameter of Comparison | Short Term Loan | Long Term Loans |
|---|---|---|
| Repayment Period | Short-term loans offer one year after borrowing to be repaid | Long-term loans are distributed in equal instalments that are payable over years |
| Collateral Requirement | No documents such as log books or title deeds are needed for these loans to act as security in case of loan defaulting. | These loans require borrowers to prove ownership of assets worth their borrowed amount to cushion lenders in case of default. |
| Ease of Acquisition | Short-term loans involve an easy application process even on mobile phones, and funds are availed quickly within 24 hours. | Long-term loans involve much scrutiny to determine creditworthiness and the ability of borrowers to pay back loans involving a long process before getting funds. |
| Amount Borrowed | In most events, these loans are taken to meet urgent liquidity requirements meaning the amount needed is not very high. | The amounts borrowed are, in most cases, intended for long-run development projects or capital-intensive needs and hence need a considerable amount of funds. |
| Interest Rates | Short-term loans attract high-interest rates because they are borrowed for short periods and lower amounts than long-term loans. | Long-term loans have lower interest rates because they are paid over many years and involve more vast amounts of money than short-term loans. |
What is Short Term Loan?
A short-term loan is a form of credit or type of loan whose capital amount borrowed, interest earned and any additional loan charges accrued are paid as per a given due date period, primarily within one year after borrowing.
These loans are characterized by short repayment periods of one year or less; they are unsecured, meaning that no collateral is required against borrowing.
They revolve around low amounts of borrowing as they seek to fix immediate liquidity requirements. Also, they attract high Annual Percentage Rates (APR).
This is a percentage expression of the actual yearly cost of funds borrowed.
APR refers to interest charged on a loan plus any additional charges on the loan, like service fees. It is set to borrowers and issued to investors.
Short Term Loans exist in different types, like LOC (Lines of Credit), which act more like a business credit card. This means that a bank or financial institution predetermines your creditworthiness and sets a maximum amount that you cannot exceed during borrowing.
Short Term Bank Loans are another type of short-term loan. They have a termination period within which they are repaid.
After repayment, if there is a need for more borrowing, you must apply afresh rather than renew the previous borrowing.
Bank overdrafts are a form of short-term loan linked to the borrower’s account. The bank sets a fixed amount in advance hence, when the bill has insufficient funds, account owners can still access funds to run their errands.
The other type of short-term loan is Merchant Cash Advances. It applies to merchants whose customers use credit cards rather than cash during purchases.
Banks or financial institutions grant the merchants funds in the form of a loan, and to repay, the bank takes a certain daily percentage from the borrowers’ daily sales.
Invoice Financing is a typical short-term loan, also called receivables financing. Borrowers seek funding using invoices due for payment by their customers, and once the debtors pay, banks recover their money with an additional service fee.
The last type of short-term loan is the borrower’s earnings determine a Payday Loan, where the amount borrowed and repayment is made when the borrower receives their following income or paycheck.
Short-term loans benefit the borrower by providing funds quickly and faster without many requirements, hence meeting their immediate financial needs without delays.
However, the disadvantage of these loans is that only a tiny amount can be borrowed. They are uneconomical for long-run projects as interest rates are pretty high, thus making them only appropriate for short-term projects.
What is Long Term Loan?
Long Term Loans are a type of debt where the capital amount borrowed, interest earned and any additional loan charges accrued are repaid over a long duration. Most times over a year to even 25 years or more, depending on the type of loan.
There are common characteristics with these types of loans: high loan amounts are issued to borrowers, interest charges on loans are low, and collateral is required during loan application.
To add on, repayable amounts are called instalments and are equally distributed throughout the payment period. Lastly, some loans, like house loans, are tax exempted because they are categorized as basic needs loans.
Long-term loans have different types that include but are not limited to education loans, home loans, and car loans. Personal loans repaid over three years or more are considered part of this category.
Small business and Long-term payday loans are grouped as long-term loans, especially if they are to be paid back over a long period.
The benefits of long-term loans include the ability to borrow a large number of funds, low-interest rates charged on loans, and affordable repayment schedules that are flexible to the borrower’s financial situation.
Demerits of these loans are not left out as the long period of payment results in an overpayment of amounts that would have been saved for other purposes. Also, the collateral required may act as a barrier for individuals or businesses that have none, locking them out of eligibility for funds.
Sometimes, for whatever reason, a borrower cannot pay the loan, which may result in stress or depression.
Main Differences Between Short and Long-Term Loans
- Short Term Loans are repaid within one year after borrowing, while Long Term Loans take years to refund the amount borrowed.
- Unlike long-term loans, short-term loans can be borrowed and granted without collater is a requirement for long-term loans.
- Long-term loans are borrowed to offset long-term ventures. On the other hand, short-term loans are taken to settle urgent liquidity issues.
- Short-term loans, in most cases, may not require any proof documentation like identification cards, payslips, and so on. As for long-term loan identification proof documents, pay proof documents are a must requirement.
- Long-term loans are associated with vast amounts of borrowing instead of short-term loans, where funds borrowed are of low amounts.
- https://www.nber.org/papers/h0137
- https://scholarworks.gvsu.edu/cgi/viewcontent.cgi?article=1000&context=library_books
I’ve put so much effort writing this blog post to provide value to you. It’ll be very helpful for me, if you consider sharing it on social media or with your friends/family. SHARING IS ♥️
Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
