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Tata Capital > Blog > Personal Use Loan > What Is Short Term Loan? Its Types & How It Works?

Personal Use Loan

What Is Short Term Loan? Its Types & How It Works?

What Is Short Term Loan? Its Types & How It Works?

You have an immediate need for funds to pay for your expenses, or maybe your business needs more inventory for the festive season. How will you gather the necessary funds for such urgent cash requirements? Will you borrow a huge sum of money and pay over several years, or will you turn to friends and family to lend you money? Neither option is suitable for you. Long-term loans for temporary needs are financially unsound, and it is often difficult for peers to arrange money to lend to someone on short notice. What you really need is a short-term loan.

What is a short-term loan? How do short-term loans work? What are some types of short-term finance? Read further to know all about short-term loans.

What is a short-term loan?

A short-term loan is a loan that you borrow for a short period to meet your immediate financial requirements. These are unsecured loans meaning you need not provide any collateral. The amount one can borrow depends on the lender and the type of short-term loan, but one can easily get short-term financing of Rs 5,000 to Rs 5,00,000.

A short-term loan’s period usually ranges between a few weeks to 24 months, and you must pay back the principal and interest within that period. 

How do short-term loans work?

When any emergency need for funds arrives, you can apply for short-term loans by visiting lender’s nearest branch, or you can do it online. Either way, lenders will perform a thorough background check and analyse credit history because short-term loans are unsecured, which is a risk for lenders.

However, documentation and background checks take no time, and short-term applications are approved quickly compared to other loans. Depending on the loan amount, lenders will set interest rates and tenure. Once your application is approved, you receive funds in your bank account in less than 24 hours. 

So, what are short-term loans used for? Since these are multi-purpose loans, you can use the fund to meet any temporary financial requirement. You can use funds to pay for personal purchases, medical bills, or a child’s education fee. Start-up founders and small business owners can use funds as working capital to support their operations. 

Depending on the type of short-term borrowing, you can repay the loan amount and interest in instalments or lump sums. And that is how short-term loans work.

What are some types of short-term loans?

There are five types of short-term loans available to you in the country. They are as follows:

1. Line of Credit

Similar to using a business and personal credit card, a line of credit provides you with a credit limit that you can utilise to fund your emergency financial needs. You must repay the credit you utilise along with interest in monthly instalments; instalment amounts vary depending on the credit you utilise. 

This short-term loan’s period has two parts – the draw period and the repayment period. You can withdraw any amount within the available credit limit during the draw period. As the name suggests, the repayment period is for paying monthly instalments.

So, how are they a better option than a credit card? Lenders charge lower Annual Percentage Rates on line of credit compared to credit cards. 

2. Merchant cash advances

A merchant cash advance is a type of short-term finance where a lender loans out a cash advance to business owners. In return, lenders get access to the borrower’s credit facility. So, every time borrower uses credit to make a purchase, and the lender gets a percentage of the proceeds. The process continues until you repay the loan in full. 

Merchant cash advances are short-term loans with period of 3 months to 18 months, and you can borrow up to Rs 5 lakhs.

3. Online or instalments loans

This type of short-term finance is the most convenient way of obtaining immediate loans. The application is completely online, and if you meet the eligibility criteria, your application is approved within minutes. Once your application is approved, the lender instantly transfers money to your bank account. 

These short-term loans’ period usually ranges from 2 months to 24 months, and you can borrow up to Rs 2 lakhs.

4. Payday loans

If you have a regular monthly income and need extra funds for emergencies, payday loans may be an ideal short-term loan option for you. You can take a loan when an emergency arises and pay it back when your pay check arrives. The amount you can borrow depends on your income.

This short-term loan’s period is usually 2 to 4 weeks from the day of borrowing. Payday loans vary from other short-term borrowings in terms of repayment. You must repay the principal and the interest amount together in a lump sum on the due date. 

Also, lenders rely on continuous payment authority to withdraw the loan and interest amount from the borrower’s bank account.

5. Invoice financing

What do you do if you run a business when some customers have made payments for their purchases, and you need extra funds? Invoice financing allows you to use those account receivables invoices and get a loan based on the duration those invoices have been outstanding. 

This short-term loan has a period of 14 days to 90 days, sometimes even more. As for repayment, every time a customer pays any of the outstanding invoices, the lender deducts interest, and the borrower gets the remaining part of the payment. 

Things to remember 

Now that it is clear what is short-term borrowing, let us see things you must keep in mind before applying for a short-term loan.

Credit score

Short-term loans are unsecured, and lenders check credit score before approving loans. Even if they approve loans for applicants with low credit scores, they charge higher interest to make up for the risk. So, make sure you have no outstanding loans or bills before you apply for a short-term loan.

Additional Cost

In addition to the processing fee, lenders also charge origination fees, credit report fees, and other charges. These costs vary depending on the lender, so compare these costs as well before selecting a lender for short-term financing.

Wrapping Up

Now you know what is short-term financing and all its types, you can easily finance your immediate temporary need for funds. If you need immediate extra financing at attractive interest rates and flexible tenure, turn to Tata Capital. They provide small-term personal loans and microfinance loans to help individuals and small businesses meet their temporary financial needs.

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