Borrowers often take out short-term loans to avoid paying the closing costs and long-term finance charges that are associated with multi-year debt instruments. Short-term financing sources include unsecured loans and lines of credit that are available through commercial banks. Borrowers can also obtain credit from payday loan companies, venture capitalists and some employers offer pension or payroll loans.
Revolving lines of credit are among the sources of short-term financing that businesses use to buy inventory. Interest rates on lines of credit are normally tied to government interest rate indexes which means that the debt payments vary from month to month. Over the long term, borrowers are exposed to the risk that rising interest rates could cause debt payments to substantially increase. Therefore, lines of credit are best suited for short-term use since interest rates do not tend to rise dramatically over periods of several months as opposed to several years. Many consumers who are confronting temporarily cash flow shortages often use unsecured lines of credit to cover day-to-day expenses.
In addition to lines of credit, most banks also offer short-term installment loans. Borrowers can take our unsecured loans and while the interest rates on these loans are higher than the rates available with secured loans, the closing costs are typically much lower. Among the short-term financing sources available to borrowers, these loans are particularly attractive to borrowers who want to have predictable monthly debt payments. As with lines of credit, installment loans are generally only available to borrowers with good credit.
Some consumers take out payday loans to cover bills that become due before payday. Check-cashing companies generally charge upfront processing fees and interest on these loans. Borrowers repay the debt by giving their paycheck to the lender. Aside from formal payday lending arrangements, some individuals enter into informal payday loan agreements with friends or family members.
Investment firms and venture capitalists sometimes provide short-term financing to individuals and businesses. These entities often charge higher interest rates than conventional lenders but borrowers with poor credit often turn to these lenders after being denied credit by commercial banks. Aside from lending to borrowers with poor credit, venture capitalists also finance speculative ventures that banks may refuse to finance.
Pension plan loans are among the short-term financing sources that some consumers turn to during times of hardship. In many countries, people who are faced with severe financial hardships that involve potential foreclosure, eviction or legal fees are sometimes able to take out short-term loans that are secured against company pension plans. Additionally, short-term financing sources available through some employers include paycheck advances in which case workers receive their wages prior to payday. Employers may assess interest or charge administrative fees on these payday loan.