What you need to know about short-term loans

Short-term loans can be applied for and received quickly. They often require little to no collateral, which makes them appear very attractive in times of crisis. However, in exchange for the convenience, you pay steep interest rates and high fees. The refund timeline may also only be a few weeks. For these reasons, short-term loans are best approached with caution.

What are short-term loans?

Short-term loans are loans with little to no collateral that must be repaid within a year or less, sometimes weeks or months. Most require proof of employment with a certain monthly salary, a bank account, driver’s license or other form of identification.

Because there is often no collateral and credit requirements are lower, these loans charge a higher interest rate (up to 400 percent) and may involve other fees and penalties.

How do they work?

Many of these loans can be applied for and received quickly. You simply submit your application (usually online) and provide proof of employment or other credit information. Then the company will review it and offer you the loan terms, including the amount, interest rates, fees, and repayment schedule. If you agree, you sign the contract and receive your money, often within 24 hours.

Most short-term loans are offered for less than $2,000, with repayment within weeks.

When should you consider a short-term loan?

A short-term loan may be worth considering if you’re in trouble and need quick cash, as they usually offer quick financing. These types of loans can also be a good choice if you have bad credit or no credit history, because the requirements for approval are based primarily on salary and other factors.

If you use a short-term loan responsibly, pay it on time and pay it off quickly, this form of borrowing can also be a tool for improving your credit score.

Additionally, if you’re looking for a form of borrowing that can help you become debt-free quickly, a short-term loan can be a good choice as the repayment term is typically twelve months or less.

However, you should only consider this form of borrowing if you are confident that you can repay the debt, as interest rates on short-term loans are exorbitantly high, as high as 400 percent or more.

Types of short-term loans

Short-term loans come in several types, each with different features, fee structures and terms:

• Payday Loans: One of the most common is the payday loan, which offers borrowers money while they wait for their next paycheck. Usually the only requirement is a pay stub to prove that you have a job. These loans often require quick repayment – ​​as soon as your next paycheck comes due – and many come with huge annual interest rates and fees.
• Car title loans: Another type of short-term loan, a car loan, allows the borrower to use their vehicle as collateral as long as they own it outright. These loans typically allow you to borrow only 25 to 50 percent of the car’s market value, with an annual interest rate of 300 percent and a repayment term of just 15 to 30 days. If you are late in paying, interest charges will increase and the loan will cost you much more.
• Bank debts: Bank overdrafts, where customers receive temporary cover from their bank at a high interest rate when their accounts do not have the necessary balance, are also a form of short-term loans. The same goes for installment loans, where borrowers receive regular, frequent payments over a period of time until the principal and interest are repaid.
• Credit lines: Some bad credit lenders offer unsecured and secured personal lines of credit to give you access to funds when needed. You can withdraw money up to the preset credit limit, and it will be replenished as you make payments. You only pay interest on the amount you borrow, and once the draw period ends, the outstanding balance is converted into an installment loan that must be repaid over a specified period of time.

Other options include lines of credit provided by banks or credit unions to bridge temporary cash flow problems and bridge loans, which can be useful during real estate transactions when a new home is purchased while the other property is still on the market.

Advantages of short-term loans

A short-term loan may seem attractive for these reasons:

• Fast Approval Timeline: The approval process for short-term loans is often very quick. You simply submit your application and proof of employment or other credit information.
• The money is provided quickly: Many short-term lenders will deposit cash into your account within 24 hours, which can be helpful if you have an emergency or unexpected expense.
• No collateral required: Unlike a secured loan, you don’t provide any collateral, such as a car or a house, to obtain a short-term loan.
• Lower credit score requirements: The credit requirements associated with short-term loans are typically less stringent than other types of loans, making it easier to get approved.

However, in most cases, the risks far outweigh the benefits.

Why You Should Avoid Short-Term Loans

While there are some benefits, short-term loans should only be used as a last resort to cover the costs that need to be paid if you have no other alternatives.

Interest rates and fees

The interest rates on these loans are often very high. For just a few thousand dollars (most lenders don’t offer much more than $10,000 or up to $15,000), the borrower can get an APR of almost 400 percent or more.

Lenders expect their money to be repaid quickly, within a year. Due to the short timeline, monthly payments will be much higher than other types of loans. In some cases, such as payday loans, the money may need to be paid back within a month or two weeks, which can put a lot of strain on your finances.

You need to make sure you have a solid plan to pay it back within the terms of the loan, because the consequences could cost you even more. If you are unable to repay the principal within the deadlines, you will be charged significant penalties.

Credit score penalties

These loans can also affect your credit score, both positively and negatively. Some companies will make a difficult inquiry into your credit, and your credit will take a slight hit. Your credit will also be negatively affected if you miss a payment or do not pay off the loan on time.

Potentially dangerous cycle

The biggest disadvantage of short-term loans is that they often do not sufficiently solve the underlying problems that cause you to need a short-term loan. In fact, with their high interest rates and fees, they often worsen the problem and become a debt trap.

You have to pay the interest and fees to get the short-term loan, so you’ll have less money the next month, making it even more likely that you’ll need another loan or refinance the original loan. More fees are charged when refinancing or extending the original loan. It is a vicious circle that is difficult to escape from.

Alternatives to short-term loans

There are alternatives to short-term loans that can work for you. While these alternatives may not work for everyone, you may want to consider one or more of the following options:

• Questions for friends and family: If you borrow money from friends and family, make sure it is clear to both of you whether and how the money should be repaid. Otherwise, the loan could damage your relationship.
• Borrowing from the equity in your home: If you have a larger emergency or an emergency that is not urgent and you own your home, you may be able to tap the equity in your home with a loan or line of credit. These alternatives usually last a few weeks.
• Buy now, pay later loan: Buy now, pay later services are becoming increasingly popular. These lenders and services allow borrowers to make interest-free installments over a set period of time, usually about six weeks. However, the terms vary widely and some plans take much longer. While the longer repayment terms can sometimes drive interest rates, buying now and paying later can be a cheaper option than typical short-term loans.
• Credit card: If your emergency can be paid for with a credit card, this may be a better and cheaper option than taking out a short-term loan.
• Personal loan: Personal loans can also be an alternative to short-term loans. The terms and rates you get will vary depending on your credit, but are usually much better than most short-term loans. Personal loans usually have a fixed repayment period of several years. If you want to pay off the loan early, look for a lender that doesn’t charge a prepayment penalty. Lenders such as Lightstream, SoFi and Upstart do not charge fees for paying off loans early.
• Personal credit line: A personal line of credit is another way to cover unexpected expenses in an emergency or to deal with a shortage of cash. An unsecured revolving account with a variable interest rate, a personal line of credit is a loan that you can draw on as needed and then pay back with interest. It is similar to a credit card.
• Salary advance: Some employers may offer salary advances, a type of loan that pays for future wages in advance. The advance will then be deducted from your future income. Not all employers offer these types of programs, and those that do typically have some form of restrictions or limitations.

it comes down to

Although short-term loans are convenient and seem like a good way to solve a temporary problem, they come with a lot of risks. The fees and interest rates can be as high as 400 percent, and the payback period can be as little as two weeks.

Missing payments will negatively impact your credit score and cost you more penalties, penalties and interest. This can lead to a borrowing cycle that is difficult to get out of. Research all your options before applying for this type of loan.