What is a Short-Term Loan - Know the Benefits of Short-Term Loans

In a world where market dynamics shift overnight, businesses often find themselves at a crossroads, requiring instant financial backing. A short-term loan is a swift, often seamless, financial solution, particularly for businesses navigating India's complex economic landscape. Let's dive deeper into understanding this credit mechanism tailored for prompt financing requirements.

What is a Short-term Loan in India?

A short-term loan in India is a credit facility that offers businesses a quick infusion of cash to cater to immediate business demands. With a repayment structure usually set within a year, they come as a respite for businesses not willing to bear long-term liabilities. These loans can be secured, backed by collateral, or unsecured, which depend primarily on a business's financial standing and creditworthiness. 

Features of Short-term Loans

Take a look at the features of a short-term loan:

• Swift Disbursement: Designed to address urgent needs, the processing and approval times are generally faster.
• Tailored Loan Amounts: Businesses can borrow as per their specific requirements, ensuring they neither under-borrow nor overextend.
• Short-lived Commitment: The nature of these loans means businesses are free from long-term debt obligations.
• Typically Collateral-free: Unsecured variants mean businesses might only sometimes have to pledge assets.
• Higher Interest Rates: The cost of quick access and shorter tenure can mean slightly higher interest rates than in the case of long-term loans.

Benefits and Drawbacks of Short-term Loans

Listed below are some of the benefits and drawbacks of short-term loans in India:

Benefits

• Rapid Capital Access: Provides an efficient way for businesses to secure funds for pressing needs.
• Simplified Processes: Less red tape is often involved, making the borrowing experience smoother.
• Retained Business Control: Unlike equity financing, there's no need to give away a stake in the business.

Drawbacks

• Higher Interest Costs: The convenience and speed can come at a price, often in steeper interest rates.
• Stringent Repayment Schedule: The shorter tenure means businesses need a plan to ensure timely repayment.

How to Get Short-Term Loans in India?

Navigating the financial landscape for short-term loans in India requires understanding both eligibility criteria and the requisite documentation.

Eligibility

• Business Reputation: Lenders typically favour businesses with a good track record, usually operational for at least a year.
• Creditworthiness: A good credit score for the business and its owner often facilitates smoother loan approvals.
• Turnover Metrics: Some lenders might stipulate a minimum monthly or annual turnover.
• Evidence of Profitability: Demonstrable profitability over the recent quarters can enhance the chances of loan approval.

Documents Required

• Proof of Business: This may include business licences, registration certificates, GST filings, and other pertinent permits.
• Financial Statements: These generally comprise balance sheets, income statements, and tax returns for the past two fiscal years.
• Ownership Details: Documentation could encompass partnership agreements or any business ownership records.
• Bank Statements: Typically, lenders request bank statements from the previous six months to analyse the business's financial health.

Types of Short-Term Loans

Below mentioned are some of the short-term loans in India:

1. Credit Card-based Loans: Instantly available for select cardholders, these often require minimal paperwork. These loans may have an interest-free term of 20-50 days. The cardholder's agreement with the bank allows for flexible repayment terms of up to 24 months.
2. Bridge Loans: With annual interest rates between 11%–18%, these loans last 2 weeks to 1 year, or extendable up to 5 years for borrowers with excellent credit profiles, bridge loans are an interim financing option. Bridge loans are a source of funding until the next stage of financing is obtained. There are no pre-closure fees, allowing you flexible repayment plans.
3. Demand Loans: The interest rates and repayment conditions for demand loans could differ greatly depending on the collateral and the borrower's creditworthiness. In general, these loans are backed by assets such as mutual funds or stocks, and they provide large sums without the need to sell assets.
4. Overdraft Facilities: Businesses that use overdraft facilities are only charged interest on the amount overdrawn, with rates adjusting according to bank and agreed-upon conditions. It provides flexibility since businesses may borrow just what they need up to a certain limit.
5. Trade Credits: Often interest-free if paid within the agreed-upon term, which is generally 30 days. There is a small repayment window that incentivises prompt settlement without additional costs. Late payments may result in extra charges or penalties. 

Invoice Finance vs Short-Term Loans

Here are a few advantages of Invoice Financing over Short-Term Loans:

• Instant Liquidity: Businesses can rapidly access funds by leveraging unpaid invoices, often quicker than traditional loan processes.
• Sales-Driven Funds: The amount available through invoice financing can grow as your sales do, offering a naturally scalable solution.
• No Need for Collateral: Since the invoices back the financing, additional collateral is generally unnecessary.
• Boosts Cash Flow: Businesses can maintain a consistent cash inflow without waiting on prolonged client payment cycles.
• Reduced Long-Term Commitment: Given the nature of invoice cycles, businesses can move forward with prolonged repayment schedules like some short-term loans.

Conclusion 

By understanding the nuances between various financing options, businesses can make an informed choice, selecting the financial tool that best matches their needs. Whether leaning towards the instant accessibility of invoice financing or the broader utility of a short-term loan, the key is to align the financial solution with the business's operational requirements and growth aspirations.