Financial Management has become a part of individuals, businesses, companies, institutions, and governments’ point of concern in their everyday operations. This is as a result of the increasing trend of financial needs by these sectors.
Further, the need to prioritize their financial needs is also a major contributor to the efficient use of their financial resources. That withstanding, growth and development is at the same time a necessity to ensure continued competitive advantage in their activities.
Moreover, their current income or available funds are in most cases deficient to meet their financial requirements in totality. Therefore, they are caught up at crossroads of what to meet, 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.
Short vs Long Term Loans
The main difference between Short Term and Long Term loans is the amount of time required to repay the funds borrowed.
This simply means Short Term Loans are issued and repaid within a short time frame usually within one year while Long Term Loans upon borrowing, they are paid back over years. The period varies between over 1 year up to even 30 years depending on the type of loan.
Comparison Table Between Short and Long Term Loans (in Tabular Form)
| Parameter of Comparison | Short Term Loan | Long Term Loans |
|---|---|---|
| Repayment Period | Short term loans offer a period of within one year after borrowing to be repaid | Long term loans are distributed in equal installments that are payable over years |
| Collateral Requirement | For these loans, no documents such as log books or title deeds are needed 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 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 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 amount needed is not very high | The amounts borrowed are in most cases intended for long-run development projects or capital intensive needs hence need a huge amount of funds |
| Interest Rates | Short term loans attract high-interest rates because they are borrowed for short periods and lower amounts compared to long term loans | Long term loans have lower interest rates because they are paid over many years and they involve very large amounts of money than the 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 mostly within one year after borrowing.
These loans are characterized by short repayment periods of one year or less, they are unsecured loans 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 simply refers to interest charged on a loan plus any additional charges on the loan like service fees. It is charged to borrowers and issued to investors.
Short Term Loans exist in different types like LOC (Lines of Credit) which acts 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, in case there is a need for more borrowing, you are required to 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 account 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 common 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 Payday Loans where the amount borrowed is determined by the earnings of the borrower and repayment is done when the borrower receives their next income or paycheck.
Short term loans have benefits to the borrower such as the ability to provide funds easily and faster without much requirements needed hence meet their immediate financial needs without delays.
However, the disadvantage of these loans is that only a low amount can be borrowed and they are uneconomical for long run projects as interest rates are quite 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 which are: high loan amounts are issued to borrowers, interest charges on loans are low, collateral is required during loan application.
To add on, repayable amounts are called installments and are equally distributed throughout the payment period. Lastly, some loans like house loans are tax exempted because they are categorized as a basic need loan.
Long term loans have different types that include but not limited to, education loans, home loans, and car loans. Personal loans that are repaid over 3 years or more are counted to be part of this category.
Small business loans and Long term payday loans are grouped as long term loans especially if they are to be paid back over a long period.
The ability to borrow a large number of funds, low-interest rates charged on loans and affordable repayment schedules that are flexible to the financial situation of the borrower are among the benefits that come along with long term loans.
Demerits of these loans are not left out as the long period of payment results to 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 to get funds. Sometimes, for whatever reason a borrower is unable to pay the loan it 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 repay the amount borrowed.
- Unlike Long term loans, Short term loans can be borrowed and granted without having any collateral which is a must 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 huge amounts of borrowings as opposed to short term loans where funds borrowed are of low amounts.
Conclusion
Both short and long term loans have different benefits and are meant to serve different needs. As you consider which loan to take, put to account how much amount needed, how fast or the time you need the loan, and the financial strength and ability to payback.
That in mind chooses a loan that favors you as a borrower depending on what you intend it for. There is no thumb rule to which loan is the best it all depends on what your needs are.
In a situation, you need urgent finances and you are sure of a plan to pay back within a short period, short term loans would be your perfect match.
Finally, where you need a longer period to settle your loan in small installments then Long term loans would be the best option.
References
- https://www.nber.org/papers/h0137
- https://scholarworks.gvsu.edu/cgi/viewcontent.cgi?article=1000&context=library_books