Short-term loans can be tempting for someone in need of a quick bit of cash: Apply for a loan, get the funds you need, and pay them back quickly.
It’s a way many people who are living hand to mouth might scrounge together emergency funds for car repairs or medical bills without needing a loan from a bank. But short-term loans are fraught with risks—high fees and interest rates, brief repayment periods, potentially unscrupulous lenders—and should be approached with great caution.
Short-term loans are easy to get
Short-term loans might be appealing for someone without savings or a credit card who needs money for emergencies. There are several different kinds of short-term loans, but in general they’re easy to sign up for, usually via an online application.
They don’t generally require the collateral and credit scores that a bank would demand. Most just require proof of employment with a certain monthly salary, a bank account, and a driver’s license or other form of ID. And they disburse the money quickly, often within just a few hours.
But short-term loans have lots of risks
But lenders also expect that money to be paid back quickly—certainly within a year, usually in just a month or two weeks—and often at exorbitant interest rates. For just a few thousand dollars (most lenders won’t offer much more than $10,000 or $15,000 at most), the borrower could be on the hook for an APR approaching 400 percent or more.
If a borrower is unable to repay the principal within the allotted window, sizable late fees begin to accrue. And that’s assuming the lender is honest. Some fly-by-night outfits could try to extract even more draconian penalties.
Common short-term loans
There’s an array of short-term loans each with different characteristics, fee structures and terms. One of the most common is the payday loan, which provides cash for borrowers as they await their next pay period. Usually the only requirement is to show a pay stub to prove you’ve got a job. But such loans often require prompt payback—usually as soon as your next paycheck clears. And many come with enormous APRs and fees.
Another species of short-term lending, a car title loan, allows the borrower to use their vehicle as collateral as long as it’s owned outright. But even those loans usually only pay out a fraction of the car’s market value (usually up to half its worth) and can come with APRs of 300 percent and repayment windows as short as 30 days.
Other forms of short-term lending
There is a constellation of short-term funding vehicles, many of which you may never have thought of as a short-term loan. There are bank overdrafts, where customers get temporary coverage from their bank at a hefty interest rate when their accounts lack the necessary funds. Or installment loans, where borrowers have regular, frequent repayments over a short period until the principal and interest have been repaid.
There are lines of credit, which could be extended by banks or credit unions to bridge temporary cash flow challenges, and bridge loans, which can be useful during real estate transactions when one house has been purchased but the older property is still on the market.
Careful with you lender and terms!
Obviously, securing short-term loans from a reputable financial institution is preferable to a storefront payday lender or a website. In any event, careful consideration should be paid to the terms of the deal. In most cases the risk and expense of such loans outweigh the value of the temporary cash they provide. If you’re unable to repay the amount under the agreed-upon conditions, you could find yourself needing to take out other short-term loans, leading to a dangerous cycle of borrowing.