The article compares the advantages and disadvantages of long-term and short-term loans. Another type of lending, known as overdraft, is also considered.
Today, no one is safe from unforeseen situations where money may be urgently needed in a sufficiently large amount. Some people need money to simply live up to their salaries or pensions, while others require funds for urgent treatments or repairs. Every situation is different and the methods of obtaining a loan may be different accordingly, depending on the amount and duration of the loans.
Cash loans can be divided into several types, depending on the period of use. In order to understand which method of lending is more profitable, read on!
To understand how short-term loans work, let’s start with their counterpart: long-term loans.
Long-term loans (also known as short-term credits) are cash loans that are issued against liquid collateral for a period of no more than a year (usually 1-3 months). Their main feature is the absence of a floating rate. Nowadays, this type of lending is the most popular among the American population. In a nutshell, this method is used mostly by those individuals who do not have the opportunity to borrow money from relatives or friends.
Long-term loans are issued by banks, microfinance organizations (MFO), or private lenders; they are divided into several types, depending on who and for how long they are used, into:
- long-term loans for legal entities (used to increase working capital, as well as for refinancing to other lenders);
- long-term loans for individuals (convenient for acquiring large household appliances, for instance); and
- overdraft, or credit limit, on the card (offered by most banks for small expenses before payday).
A short-term loan (also known as a payday loan) is a loan, for up to a month, that often comes with very high interest rates but has several benefits. Short-term loans can be of two types:
- Standard – After the borrower submits an application, the company’s specialists evaluate the client’s solvency and make a decision on the issue of funds (more profitable when calculating the interest rate).
- Extra – Within a few hours, the company’s specialists decide to issue funds without checking solvency (less profitable and more convenient as it is processed online).
Employees of a company or a bank start by checking the client’s credit score. If the borrower has delayed payment on any of the previous, or existing loans, under the agreement the banks may refuse to lend at all. Micro-financing lenders most often will, albeit at an exorbitant interest rate. In this case, it is also possible that the borrower will have to resort to the services of private brokers.
The Risks of Short-Term Lending
If the client’s credit score is poor, any financial institution assumes a higher risk that the short-term loan will not be repaid. It is also worth considering that MFOs issue such urgent loans without any collaterals, co-signers, or statements of income. They only base it on the information provided by the client and his social security number. In case of insolvency, the only possible way for the lender to return the money may be a trial, but in such a situation it may turn out that the debtor simply has nothing and declares bankruptcy.
However, despite the risks, the demand for short-term loans is growing. Consequently, even when banks refuse to issue such loans, you can find a wide selection of microcredit organisations that will. You can usually borrow up to $2,000 without much hassle, and at a decent interest rate, too. But keep in mind; delayed payments, let alone a failure to repay the loan, may result in hefty fines and significant damage to your credit history.
If you own a bank account, you’ve probably heard the term “overdraft” before, and the option to use it comes with the need to pay fees (which usually range between $35 and $50). Overdraft allows you to withdraw more money from your bank account than you actually have there, with an upper limit of how much you can withdraw. Sometimes you can even withdraw cash at an ATM with a commission of 1-5%, depending on the bank.
Due to the commission interest on the withdrawal and penalty fees, as well as attracting new customers with a useful feature, overdraft is both profitable and beneficial to banks. As far as the borrowers are concerned, overdraft is also very convenient because there is no need to apply for a loan and wait, especially if you only need a small amount. This way, you can make urgent purchases and spend extra money on short notice, leveraging a comparatively low interest rate on loan.