It’s not always easy to find the cash you need to fund your business—and it’s even harder if your credit is less than stellar. You may have heard that borrowers with poor credit history might have an easier time getting approved for short-term loans; you may have also heard that these loans can come at a higher cost and, of course, require a quicker repayment turnaround. So, if you’re considering one of these business loans, that might lead you to the question: Do short-term loans affect your credit rating?
The short answer is, it’s complicated. Short-term loans affect your credit rating, as do as any other loan. Any time you borrow money and pay it back according to the loan’s terms, your credit rating improves. If you don’t pay your loan back, your credit rating suffers.
The risk of a short-term loan affecting your credit rating is in the loan’s terms: Most require daily or monthly payments, and come with higher interest rates than longer term loans. And even if you’re not able to pay—say you’re tight on cash flow or haven’t gotten your incoming invoices paid yet—you’re still on the hook. And not paying your loan bills could be ruinous for your credit score.
There’s actually a different question you should be asking, too: Are short-term loans the only option if your score isn’t perfect? The good news is that there are a ton of options out there for borrowers with a variety of credit histories—you’ll just need to do some research to find the right fit. Here, we’ll show you how short-term loans could affect your credit rating and how to find your best alternatives.
You always expose your credit score to change whenever you borrow money—be it due to a $10 credit card purchase or a billion-dollar bank loan. When a lender allows you to borrow money, you make a promise that you’ll repay it under certain terms, and your credit rating is a numerical reflection of whether or not you stay true to your word and pay your bills (not how quickly you can make payments or how much money you can get from a lender). It’s a reflection of your history with debt.
So, just like any other kind of loan you might get, short-term loans could affect your credit rating negatively. If you pay your loan bills in full and on time, then your short-term loan might actually boost your credit score.
But short-term loans may be harder to pay off than other types of loans. Typically, these loans require expensive and frequent payments, and you only have a short period of time to pay them off (hence the name). If you can’t afford to make those daily or weekly payments, or are worried about short-term cash flow, you may end up damaging your credit in the process—especially because the terms of repayment aren’t necessarily stacked in your favor.
Practically, short-term loans from online lenders are just a miniaturized version of your standard, longer term loan traditionally furnished by banks: a lump sum of capital delivered to your business bank account, which you’ll need to pay off, plus interest, over a predetermined amount of time. For that reason, short-term loans might seem like pretty desirable financing products—if approved, you’ll see that capital fast, and you can use it for almost any project you have in mind.
And, for the right borrower, short-term loans can work wonders to grow and support businesses.
By “the right borrower,” we really mean the borrower who can meet their short-term loan’s terms, which can be demanding. Most short-term loans require rapid payment less than a year—generally between 3 to 18 months. They also come with higher interest rates than long-term loans do—sometimes, that means double or triple the interest rate of a three- or five-year loan.
Due to those less-desirable repayment terms, it can be easier for borrowers with spottier credit histories to obtain a short-term loan than, say, a long-term bank loan. But that’s one of the benefits to these types of loans—their accessibility.
Those terms are a double-edged sword, though, because they might make it harder for cash-strapped small business owners to repay on time. And if that’s the case, the risks to your credit score outweigh the benefits of fast cash.
A short-term loan isn’t your only option, even if your credit history is less-than-perfect. Before taking the risk of a short-term loan affecting your credit rating—or any loan, for that matter—consider why you need the money, what you can realistically afford, and how you’re going to use that capital.
It’s possible that a short-term loan simply doesn’t suit your intended use of funds.
For instance, if you just need to pay for your business’s daily expenses, there’s no reason to apply for (and need to repay) a short-term loan’s capital amount and interest rate. Instead, you’d be better off with a business credit card with a low APR. You’d only owe your creditor the odds and ends you paid for, according to terms that make sense for your business and budget. If you can meet those terms, your credit score won’t get hurt.
If the prospect of a short-term loan affecting your credit rating worries you, you’re probably concerned that you won’t be able to make your daily or monthly contributions. In that case, consider whether the following alternatives might be a better fit for your finances, as well as the primary objective you have for the loan. These loan products could be better suited for the purposes that you need cash and, subsequently, you might have an easier time paying off these bespoke loans rather than a catchall term loan.
A business line of credit is a fabulous alternative to short-term loans if you need a bit of cash to help finance smaller projects or incremental purchases. These revolving resources allow business owners to borrow money on a rolling basis, taking only what they need, when they need it. And, best of all, only paying interest on what they borrow.
Business lines of credit can be much more borrower-friendly than short-term loans, because they don’t require immediate repayment or come with inflexible terms. Plus, you don’t need excellent credit in order to get one.
Short-term loans make sense if you need to finance a large, one-time purchase, like a business expansion. But because they’re evergreen, business lines of credit can be even more flexible than that; use them for whatever projects or opportunities arise. For instance, you can use a line of credit as an alternative to a short-term loan if you need to restock inventory, cover emergency expenses, or simply want to tap into a source of financing on an ongoing basis without having to apply for a loan every time.
In most cases, a smaller, shorter-term line of credit comes with an easy, fast application process. Larger (and longer-term) lines of credit could require more paperwork, and may come with a longer lead time.
Business credit cards aren’t quite in the same category as loans, sure. But they’re still a great alternative to short-term loans. Business credit cards still allow cardholders to make purchases and pay for them later on, generally with less frequent repayment terms (monthly instead of daily or weekly).
Plus, depending on the terms of your loan, some business credit cards can offer a lower APR than short-term loan interest rates—which will, of course, only matter if you don’t pay off your balance in full.
Particularly helpful, though, are business credit cards with 0% introductory APR periods. This means that cardholders get what amounts to an interest-free loan for the duration of introductory rate—and some cards offer periods of a year or more. That’s the length of many short-term loans, and no short-term loan can come close to free—even if that offer only applies for a limited time.
Of the 0% APR cards, we love the American Express Blue Business Plus because of its 12-month 0% introductory APR period. After the 12 months, a variable APR will set in according to your creditworthiness and the market Prime Rate, so you’ll want to check with the issuer for details. But that gives you more than a year to finance whatever you need to.
(And, if you pay your bills on time, you can even improve your credit score. Nice.)
Invoice financing, otherwise known as accounts receivable financing, helps small business owners cover their invoice payments without having to take out larger loans, like a short-term loan. Lenders will advance business owners with cash based on the amount of money they anticipate coming in from outstanding invoices.
Borrowers can then use the money to make purchases with 85% of the total value of the invoices they put up as collateral. Most of the remaining 15% is returned to business owners later, sans fees.
Invoice financing can sometimes get a bad rap—businesses don’t want to be seen as having cash flow problems. But think about the big picture: That’s not what invoice financing is about.
If you’re a B2B operation that invoices on net 60, 90, or even 120 terms, there’s a chance you’ll have some much-needed money tied up in trade credit. Your trusted customers will pay, of course. But if you’ve given them a few months to do it, and you need that money now, you’re better off working with a lender to front you what you’re due than taking out a short-term loan. If you’re cash-strapped in the first place, you won’t be able to make the frequent repayments—and your credit will take a hit.
That’s why lots of big companies rely on invoice financing.
Equipment financing is a great alternative to a short-term loan if you’re looking to specifically purchase machinery or tools to keep your business humming. These loans are specially designed to help business owners purchase equipment.
And since equipment loans use the equipment itself to secure the loan (meaning your lender will reclaim and sell your purchase if you can’t pay up), they generally don’t require any additional collateral.
Equipment loans let you buy the items you need without making you pay back your loan with lightning speed and high interest rates. This could definitely be a consideration for business owners who can’t generate revenue until you replace your broken-down machinery—you especially might not be able to make short-term loan payments in that case!
Small business loans are intended to help small business owners, not hurt them. So, if you’re worried about your loan negatively impacting your credit score—whether that’s a short-term loan or something else—then you’ll want to explore a different kind of business loan product.
Short-term loans can work beautifully for small business owners who need access to fast capital; don’t have the high credit score that lenders need to see to extend long-term loans; and, most importantly, can meet their loan’s repayment terms. If that list’s last item is true, then you won’t need to worry about damaging your credit score. On the other hand, a short-term loan will damage your credit scores if you can’t meet your loan’s repayment terms.
But with so many other kinds of loans available, no small business owner is locked into a short-term loan exclusively. If you don’t think you can afford a short-term loan, work with a loan specialist to help you figure out an alternative financing method that you can truly afford. That way, you’ll have access to the capital you need, without the risk of hurting your credit score—and, actually, the possibility of improving your credit score, as long as you meet your payments on time.
Brian O’Connor is a contributing writer for Fundera.
Brian writes about finance, business strategy, and digital marketing. He is the former director of digital strategy at Morgan Stanley, and has worked at Foreign Affairs magazine, Student Loan Hero, and as a partner of a small consulting firm, too. Combined, these experiences allow him to offer a unique perspective on the challenges small business owners face.