What To Know About Short-Term Loans

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Short-term loans offer quick funding and often require little to no collateral, making them seem attractive in a crunch. In exchange for the convenience, however, you’ll pay hefty interest rates and high fees — and the repayment timeline also may only be a few weeks long. For these reasons, short-term loans are best approached with caution.

What are short-term loans?

Short-term loans are for small amounts — usually under $1,000 — that you repay in a year or less, sometimes as soon as your next payday. Lenders typically require proof of income, a bank account and a form of government-issued ID. Some, like car title loans, may also require collateral.

The application process is usually online, and many short-term loans can be applied for and received quickly. If approved, you’ll receive your loan terms, including the total amount, interest or finance charge, any fees and a repayment schedule. 

Before taking out a short-term loan, it’s important to fully understand the risks and costs associated with them. These loans are a high-cost solution for emergencies, and depending on your state, the interest rate or finance charge may be equivalent to a triple-digit APR (annual percentage rate). In addition, because the repayment timeline is much shorter than traditional loans, keeping up with payments can strain your finances. While a short-term loan can be useful if you have no other options available, it’s a good idea to seek alternative lending options first. For instance, a bad credit personal loan may provide access to funds without steep fees.

Types of short-term loans

There are several types of short-term loans, and each has its own fee structures and terms. While the specific details surrounding each loan option may vary slightly, the common characteristic of short-term loans is that they’re more expensive than traditional loans. Read the fine print carefully before you apply to ensure you understand the full cost.

• Cash advance apps: A cash advance app allows you to borrow money from a future paycheck when you’re in a crunch. These apps tend to charge lower fees than other short-term loans, or in some cases, may only require an optional tip.
• Emergency loans: An emergency loan is a type of installment loan that can help fund unexpected expenses. You will have regular, frequent payments over some time until the principal and interest have been repaid.
• Bank overdrafts: While not technically a loan, bank overdrafts allow you to withdraw funds from your bank account even when you don’t have enough funds. However, this option typically comes with a costly overdraft fee.
• Payday loans: A payday loan is one of the more expensive options, but they may be more accessible if you don’t qualify for other options. However, these loans often require prompt payback — as soon as your next paycheck clears — and often have significant financing charges that lead to a high APR.
• Car title loans: If you own your car outright, a car title loan allows you to use your vehicle as collateral. You may be able to borrow up to 50% of your car’s market value, but like payday loans, they can come with high fees and repayment windows as short as 15 to 30 days — with a potential repossession if you fail to repay.

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

When to consider a short-term loan

Short-term loans may seem attractive for a few reasons, but often the risks far outweigh the benefits.

A short-term loan may be worth considering when you’re in a crunch and need cash quickly. They may also be worth considering if you have poor credit or no credit history established, as the requirements for approval are primarily based on your income and other factors.

Other benefits, like an increase to your credit score, will depend on the lender. In some cases, making payments on time and paying your loan off quickly can also be a tool to boost your credit score. Additionally, if you’re looking for a form of borrowing that allows you to be debt-free quickly, a short-term loan may be a good choice, as the repayment timeline is typically 12 months or less.

However, you should only consider a short-term loan if you’re confident you can repay the debt. Interest rates and fees on short-term loans are exorbitant, with many having a 400% APR or higher.

Alternatives to short-term loans

While these alternatives may not work for everyone, you might consider one or more of these options before you take out a short-term loan.

• Asking friends and family: If you borrow money from friends and family, make sure everyone is clear on how the money should be repaid — otherwise, the loan can damage your relationship.
• Buy now, pay later loan: Buy now pay later (BNPL) services are growing in popularity. They allow borrowers to make interest-free installments over a set time, typically about six weeks. While choosing a longer repayment timeline may sometimes mean paying interest, a BNPL loan can be a less expensive option than typical short-term loans.
• Credit card: If you can use a credit card for an emergency expense, it may be a better and cheaper option than taking out a short-term loan. Credit cards can be used to cover nearly any type of expense, whether it’s home, auto or medical bills. And the interest rate is likely to be lower than a short-term loan.
• Personal loan: Personal loans can also be an alternative to short-term loans. The terms and rates you get vary depending on your credit, but they’re usually much better than most short-term loans. Personal loans typically have a fixed repayment period of a couple of years, which means smaller, more manageable monthly payments.
• Personal line of credit: A personal line of credit is another way to cover unexpected expenses in an emergency or help meet a cash shortfall. You can draw from your credit line as needed. And similar to a credit card, you only pay interest on the amount you use.
• Salary advance: Some employers may offer salary advances — paying you in advance for future wages. The advance is then deducted from your future earnings. Not all employers offer this type of program, and the apps may charge a fee or interest for the service.

Bottom line

Although short-term loans are convenient and may seem like a great way to fix a temporary problem, they come with many risks. The fees and interest rates can top 400%, and payback terms can be as little as two weeks.

Missing payments will negatively affect your credit score and cost you more late fees, penalties and interest. This can lead to a cycle of debt that is difficult to break out of. Research all your options and consider alternatives before you apply for a short-term loan.