Originally posted on https://bonsaifinance.com/a-beginners-guide-to-short-term-loans-lc/
57% of adults have less than $1000 in savings in the United States. For this reason, short term loans are a popular way to deal with emergencies.
People take out loans for a number of reasons. Maybe you’re starting a business, you’ve had an unexpected expense, or your bills are simply stacking up on top of each other.
While short term loans can give you some necessary breathing room, it pays to understand your rights and obligations. If you’re thinking about taking out a loan, this guide will teach you everything you need to know before you sign on the dotted line.
Ready? Let’s get started.
What is a Short Term Loan?
Borrowing can make many things possible. If you can’t afford something you need, borrowing can help you get it. But borrowing can also be expensive, and if you’re not careful, it can negatively impact your finances.
Short term loans are generally any type of loan that needs to be paid back in less than a year. These can be taken out for either business or personal purposes and can cover any emergency expenses between paychecks, education expenses, healthcare bills, or even a vacation.
Unsecured loans are any type of loans that don’t require you to secure the loan with an asset. That means that assets like your home or car are not on the line. Some of the most common types of unsecured personal loans include:
Payday Loans
Payday loans are a type of short term loan. These are typically approved within 48 hours and you can request these online. These are usually up to $2,000, however, they do often have higher interest rates due to the short timeframe and few requirements for approval.
Flexible Loans
Flexible loans are another type of short term loan. These are usually credit-based, but you can borrow up to $25,000.
Bad Credit Loans
If you have bad credit (or no credit) you can often still qualify for short term loans. But these will also have a higher interest rate due to the lender’s increased risk.
Credit Cards
Credit cards are one of the most popular choices for people needing money quickly. When you have a credit card, you’ll be spending against a line of credit. And you can borrow and repay your debt repeatedly.
These can be expensive, and often have high interest rates and annual fees, but you can often find credit cards with low or 0 interest rates for a short period of time.
Consolidation Loans
These are a great way to combine your current debts. If you can find a loan with a lower interest rate than your existing debt, you can lower your monthly payments or borrowing costs. This means that you’ll be able to pay back the balance of your debt and spend less money on interest.
How Short Term Loans Work
While short term loans may seem simple, it’s important to understand the mechanics of these loans so you can make smart decisions.
Here are some things you should know:
Interest
Interest is what makes your lender willing to lend you money. You can expect to pay extra fees, but most of the cost should be solely interest charges on the loan. The lower the interest rate, the better.
Monthly Payments
These are the payments you’ll see leaving your bank account each month. This amount will depend on your interest rate, how much you’ve borrowed, and any other factors.
Length
The length of your loan will determine the total interest and monthly payments. Short term loans will sometimes have higher interest rates but you’ll usually pay less interest over the life of the loan since you’ll pay the balance off faster.
Credit
This is your borrowing history. Lenders will look at your credit and use your past history to predict whether you’re likely to pay off your short term loan. To do this, they’ll review your credit reports. Computers automate this process with the creation of a credit score.
The higher your credit score, the more likely that your loan will be approved and the better your interest rate is likely to be. Even if you have a poor credit history, you can still get a short term or payday loan from many lenders.
It’s important to remember that you can still have an excellent credit score even if you use short term loans. Borrowing too much will eventually impact your score, especially if you miss a payment or default on your loan.
Income
Lenders will always want to see that you have enough income to pay back your loan. Lenders will calculate your debt to income ratio so they can see how much of your income is already going towards debt repayment.
You’re less likely to get approved if you a large portion of your income is spent on debt payments.
Risks and Costs of Loans
It’s easy to see the benefit of a short term loan — you can get out of a tight spot or launch a new business and pay it back later. But it’s important to have the full picture and keep the following points in mind as you decide whether you should get a short term loan.
Payments
It won’t be surprising to hear that you need to repay the loan. But it’s important that you understand what these payments will look like.
It can be tempting to assume you’ll figure it out once you’ve got your loan. It’s important to borrow wisely and ensure that you can still make payments in the event that you have a change in expenses or job loss.
Cost
When you’re repaying a loan, not only are you repaying everything you’ve borrowed, but you’re paying extra. Typically this extra cost is interest, but with some loans, this may not be easy to see.
It’s a good idea to work out how much you would pay in interest over the life of your loan. Even with short term loans, it’s worth considering whether the interest payments are worth getting your hands on the money you need more quickly.
Flexibility
Money gives you more options, particularly if you’re thinking about starting a business. But at the same time, once you’ve signed for a loan, you’re stuck with that loan until you’ve paid it off.
If you’re hoping to make a big change, this often isn’t an option until you’ve paid off the debt.
Should You Get a Short Term Loan?
The first thing you should do before you get a loan is figure out exactly how much you need to borrow. This ensures that you’re being realistic about exactly what you need the money for.
You don’t want to take out a short term loan and realize that you need more money than previously anticipated. You also don’t want to take out too much money with a loan, because you’re likely to end up spending it and needing to pay back more money than you needed.
The next thing to consider is whether you need cash. Could you fulfill the same objective by using another type of credit? This is often possible if you’re buying a product.
Finally, think about how long you’ll need to borrow this money for. It’s hugely important that you’re realistic here. Don’t underestimate how long you’ll need to pay back the balance of the loan, as this can lead to huge amounts of interest if you take longer than agreed.
Once you’ve decided you need a loan, it’s time to consider which short term loans offer the best value for you.
Choosing Your Loan
Before choosing your loan, it’s a good idea to compare interest rates from multiple lenders. The APR or annual percentage rate is the amount of interest you’ll pay on your loan, calculated on a yearly rate. It also includes any extra fees or finance charges.
The APR is one of the most important aspects to look at when you’re comparing loans. That’s because it allows you to get an apples-to-apples comparison. The monthly payment or interest rate alone don’t reflect the true cost of each loan.
Often, lenders will offer you an interest rate based on your credit score. Online lenders can allow you to get a quote without impacting your credit score.
Wrapping Up
Short term loans can help you get ahead and pay off mounting bills. You can use a short term loan to rebuild your credit history, create financial peace of mind, or even start a business.
By using the above information, you’ll be able to borrow responsibly. That means understanding exactly how much you’ll be paying back each month. It also means comparing products and APRs so you get the best deal.
Before taking out a loan, make sure you have a plan for paying it back. Borrowing responsibly will help you get ahead financially.
Need help with your loan? Our online calculator will show you how much you can borrow. And we’re just a call or email away if you need assistance.