Tags: perils | short | term | financing | loans

4 Risks of Short-Term Financing

A neon sign at a loan shop.
Karin Hildebrand Lau | Dreamstime.com

By
Wednesday, 19 September 2018 11:55 AM Current | Bio | Archive

It's a $40 billion industry — but some people avoid it like the plague. It's also on the decline, according to reports. It's known as "short-term financing," and it can be used to great effect or great risk, depending on the individual seeking out the capital.

But what exactly is short-term financing, and can it improve your finances—or would you be better off avoiding it?

The Forms of Short-Term Financing

Most people seek short-term financing in one of the following forms.

  • Payday loans: This kind of loan is issued after a lender evaluates a borrower's current income and credit rating. The lender will use income-based information to generally issue a high-interest loan, with the assumption that once the borrower receives their paycheck, they'll be able to pay off that loan quickly. According to Investopedia, these may be considered "predatory" loans that take advantage of a borrower with little recourse for short-term financing.
  • Credit card cash advances: This is essentially a short-term loan from a credit card company, but they can also come from banks and a variety of lenders. Like payday loans, these advances also come with steep interest rates and potential fees, which is why it's important to read the fine print when considering a cash advance.

What Are the Benefits and Drawbacks to Short-Term Financing?

Before securing a short-term loan, it's important that every consumer know the pros and cons to this arrangement.

Pros:

  • You can often borrow a small amount of money with short-term financing, making it possible to minimize the amount of interest accrued. For example, many short-term loans come with a minimum as low as $50.
  • These loans can be effective for addressing short-term cash shortages on an emergency basis. A cash advance can provide additional backup liquidity, especially for those who can pay it back within a short amount of time.

Cons:

  • The stiff fees and high interest rates associated with short-term financing can be prohibitive to most people—especially those with the most money issues. For that reason, payday loans are considered by some to be predatory loans. In some cases, the annual interest rates reach as high as 838%. That's not a typo.
  • Without the ability to pay them off, short-term financing can trigger a vicious cycle of debt, putting some customers deeper into debt issues.

What You Need to Know Before Taking Out a Short-Term Loan

A short-term loan can help shore up a lack of liquidity in some cases. But only those who are confident in their ability to handle money and with enough experience reading fine print should engage in short-term loans, especially if they're certain they'll have the money to cover it. People interested in short-term financing should also keep the following in mind.

  1. APR. If you don't know what APR is, you shouldn't feel confident in your ability to pay back these types of loans. APR refers to the annual percentage rate—or the interest rate—of the loan. Because short-term financing comes with short-term payments, the APR can be drastically higher than other types of financing. While it's not uncommon to see credit cards with an APR of 20%, the APR on a short-term payday loan can reach 200% or more. That can mean borrowers end up paying double or more on what they originally borrowed—simply for the right to borrow.
  2. Hidden fees and overdraft fees. While a payday loan might sound intriguing because payday is just around the corner, the hidden fees associated with short-term financing can make the process more complicated. When these fees make it impossible to pay back the entire loan at once, the high interest rates kick in, burying the borrower in even more debt than anticipated.
  3. Future income is not always guaranteed. Borrowing short-term money at extremely high interest rates does result in money now, but this money is borrowed against the future. If future income is not guaranteed—for example, you're depending on a bonus at work or an increase in sales for your business—then short-term financing is generally a bad idea.
  4. Credit risk. Failing to pay off a short-term loan can result in further damage to one's credit rating, which in turn will drive up the cost of future debt, even long-term financing for a home.

In some extreme cases, it may be better to maintain a balance on a credit card rather than resort to the higher APR of short-term financing to get by—such as charging money on a credit card for groceries and basic necessities.

There are a lot of cautionary tales in the world of short-term financing. But what does that mean for you? Those who need liquidity fast should be wary of these offers and scrutinize every detail of their personal situation before applying for a cash advance.

Joe Resendiz is a Research Analyst at ValuePenguin, where he focuses on personal finance and credit research to assist consumers. Previously, Joe specialized on public sector and infrastructure financing at Goldman Sachs. He graduated from the University of Texas at Austin with a BBA in Finance.
 

© 2019 Newsmax Finance. All rights reserved.

   
1Like our page
2Share
JoeResendiz
There are a lot of cautionary tales in the world of short-term financing. But what does that mean for you? Those who need liquidity fast should be wary of these offers and scrutinize every detail of their personal situation before applying for a cash advance.
perils, short, term, financing, loans
841
2018-55-19
Wednesday, 19 September 2018 11:55 AM
Newsmax Media, Inc.
 

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved