Short-Term Loans Defined And Explained

Short-term loans are a way to borrow and repay cash quickly. They’re relatively easy to get and rarely require collateral. They usually have higher interest rates than secured loans, which can make them a more expensive way to borrow. Learn how short-term loans work, how to get one, the pros and cons, and how to choose the right one for you.

Key Takeaways

• Short-term loans offer borrowers small amounts of cash that they can repay quickly.
• While they are easier to get than personal loans, short-term loans often charge fees and high interest rates.
• Typical short-term loans include payday loans, pawn shop loans, credit card cash advances and auto title loans.

What Is A Short-Term Loan?

A short-term loan is a relatively small loan that’s paid back quickly, typically in a few weeks or months. Short-term loans can fill immediate financial needs and are helpful in an emergency. However, they usually charge higher interest rates than long-term loans, making them an expensive way to borrow money.

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How Does A Short-Term Loan Work?

The key feature of a short-term loan is that it’s repaid quickly. This allows borrowers quick access to relatively small sums of money they don’t have to take years to repay. These loans typically are aimed at people with low incomes, as moderate- to high-income earners usually don’t need to borrow small amounts.

That means lenders take on more risk when offering short-term loans, and to make a profit, they need to charge higher interest rates than you might get with a personal loan for a larger amount.

“Although they are frequently simpler to qualify and apply for, the short payback turnaround time and higher interest charges may make repayment more difficult,” says Steven Kibbel, a certified financial planner in Franklin, Tennessee.

Types Of Short-Term Loans

Short-term financing comes in several different forms. You’ll want to weigh what’s available to you with your needs to decide which is the best fit.

Payday Loans

Payday loans let employed people borrow small amounts of money they repay when they get their next paycheck, usually within two to four weeks. The loan amounts are generally limited, with many states capping these loans at $500. Lenders often ensure repayment by requiring borrowers to provide a post-dated check or electronic transfer timed to their next payday.

Payday lenders typically don’t check your ability to repay. While some loans require a lump-sum payment, others can be extended or paid in installments. Fees range from $10 to $30 per $100 borrowed, which pencils out to an annual percentage rate as high as 400%.

“Payday loans tend to be a higher risk for lenders and usually carry higher interest rates that reflect that risk,” says Bobbi Rebell, a certified financial planner in Boca Raton, Florida, and a personal finance expert at BadCredit.org. “Payday loans are secured by the borrower’s next paycheck, but if you cannot repay the loan plus interest at that time, these loans tend to roll over to the next paycheck. These loans are usually extremely expensive for consumers and are often a loan of last resort.”

Auto Title Loans

An auto title loan uses your vehicle’s title as collateral. In exchange for the loan, you pay a fee and typically must repay the full amount within 30 days. The lender can seize your vehicle if you default on the loan.

Finance fees on title loans can run as high as 25% a month, which is equal to an APR of about 300%. If you wanted to borrow $1,000 with an auto title loan, you’d pay $250 in interest – plus any additional fees.

To get an auto title loan, you must present the lender with your application, car title and photo ID. Some also may request a spare set of keys or require you to buy a roadside service plan. If the lender approves your loan, it will hold your auto title until it is repaid. When it’s time to repay the loan, typically due in 30 days, you will need to pay back the amount borrowed and any additional fees.

Pawn Shop Loans

Pawn shop loans use a personal item as collateral, often jewelry, electronics, tools, musical instruments, collectibles, antiques or precious metals. You provide the item to the pawn shop lender, who keeps the item as collateral on the loan. Unlike traditional banks, pawn shops don’t require credit checks. If you fail to repay the loan on time, the pawn shop keeps the item and is free to sell it to someone else.

These loans are usually for less than $1,000, with interest rates running as high as 25%. Repayment terms are often one or two months.

Credit Card Cash Advance

This option involves borrowing against your credit card’s available cash advance limit. It’s an easy way to borrow money if you have a credit card, but it also can be expensive.

Most credit card issuers will charge a fee to take out cash. The fee often is a $10 minimum up to 5% of the amount you’re borrowing. On top of that, interest rates are between 25% and 30%.

“Not only are borrowers charged extremely high interest rates compared to regular purchases, but credit card companies also can tack on high fees either as a flat fee or as a percentage of the amount owed,” Rebell says. “Also, there is no grace period, so borrowers are paying interest immediately after accessing the money. Cash advances through a credit card company can also be a signal to credit rating agencies that you may be in some financial trouble and can potentially harm your credit score.”

Cash-Advance Apps

Apps such as Dave or EarnIn let you borrow small amounts based on your expected paycheck.

“Before your salary arrives, you can borrow tiny sums of money with these apps,” Kibbel says. “They typically don’t charge interest but instead demand fees or ‘tips.’”

Additionally, cash-advance apps often require automatic repayment timed to the deposit date of your next paycheck.

Buy Now, Pay Later

Buy now, pay later services like Afterpay or Klarna allow consumers to split larger purchases into smaller interest-free payments, so if you make the payments on time, you pay no interest.

“These are typically offered at the point-of-sale for retail purchases and can be helpful if used responsibly,” says Dennis Shirshikov, a professor of finance and economics at Queens College, City University of New York, in New York City. “But missed payments can lead to costly fees and negatively affect your credit.”

Pros And Cons Of Short-Term Loans

Short-term loans have advantages and disadvantages compared to other borrowing options.

Advantages Of Short-Term Loans

Cons

How To Compare Short-Term Loans

It’s important to compare short-term loans when shopping around for financing. Consider the following criteria when evaluating short-term loans:

How To Get A Short-Term Loan

Eager to pursue short-term financing? Here are the steps involved.

1. Ensure You Meet The Requirements

Review the lender’s criteria for getting a loan. Qualifying for a short-term loan depends mainly on your income and credit score.

2. Choose A Loan And Apply

Consider the different types of short-term loans and decide which one best meets your needs. Get estimates from a few lenders and compare their offers, looking for the best deal from a reputable blender with transparent terms. Once you choose a loan type and a lender, you can apply.

3. Receive Your Funds

Once approved, you should receive your short-term loan funds quickly – often within a day or so.

FAQ

Here are the answers to some frequently asked questions about short-term loans.

The Bottom Line

Short-term loans offer a reasonably simple way to borrow a small amount of money for a few weeks or months. Many borrowers appreciate that convenience and the fact that eligibility and approval are often easier with this type of financing. Just be careful before committing to a short-term loan: You will likely pay much more for this financing at higher rates and fees than other types of loans.

More From Quicken Loans:

• How Do Personal Loans Work?
• Personal Loan Prequalification: What It Is And How The Process Works
• What Is An Installment Loan And How Does It Work?
• Same-Day Loans: What They Are And How They Work
• What Are Collateral Loans And How Do They Work?