The Three Main Types of Unsecured Short-Term Loans

Getting access to funding is vital for businesses to operate and grow. While there are various funding options available, short-term loans offer a flexible way for businesses to obtain financing. Unsecured short-term loans in particular don’t require collateral, making them an accessible option for many companies. This article will explore the three main types of unsecured short-term loans trade credit, bank loans, and commercial paper.

What Are Unsecured Short-Term Loans?

Unsecured loans are those that don’t require the borrower to pledge an asset as collateral. This differs from secured debt like mortgages or auto loans that are tied to a specific asset that can be repossessed if the borrower defaults.

Short-term loans are designed to be repaid in less than a year, though some may have terms up to 18 months They provide quick access to funding that businesses can use for daily operations, unexpected expenses, or short-term projects.

Combining these two factors, unsecured short-term loans offer accessible financing that businesses can obtain without tying up valuable assets as collateral. Their unsecured nature does come with higher interest rates and stricter qualification requirements compared to secured debt. But for businesses that need fast funding and don’t want to put up collateral, these loans fill an important niche.

Now let’s look at the three main types of unsecured short-term loans available:

Trade Credit

Trade credit allows businesses to purchase goods and services without immediate payment. The business receives the products or services right away but has an agreement with the supplier to pay at a later date, typically in 30, 60 or 90 days.

This delayed payment represents an interest-free, unsecured short-term loan. It provides an easy source of funding for inventory, supplies, and operating expenses. Trade credit is also flexible since repayment terms can be negotiated with each supplier.

Trade credit is commonly offered by suppliers, service providers, and wholesalers to businesses in their distribution chain. It helps facilitate the regular sale of goods and services. Companies like grocery stores, restaurants, retailers, manufacturers, and distributors all regularly use trade credit.

For suppliers, offering trade credit can encourage greater sales volume from business customers. It also builds loyalty and long-term relationships. On the buyer’s end, trade credit provides an efficient way to fund routine purchases and smooth out cash flow. It’s one of the most widely used sources of short-term financing for businesses.

Bank Loans

Banks provide a variety of short-term loan options that businesses can use to obtain quick financing. Common types of unsecured bank loans include:

• Lines of Credit – This provides access to a preset borrowing limit that can be tapped as needed. Only interest is paid until the balance is due.

• Term Loans – These loans offer a lump sum of cash upfront and are repaid in regular installments over short periods of 3 months to a year.

• Credit Card Financing – Business credit cards allow companies to pay for purchases over time while accessing a revolving credit line.

• Overdraft Protection – This covers overdrafts in a business checking account up to a set limit for a small fee.

Bank loans offer straightforward access to financing that can be tailored to a company’s needs. Qualifying for an unsecured bank loan requires a strong credit profile and financial track record. Interest rates are also typically higher than for secured loans. But bank loans are a flexible funding option for covering operating expenses, unexpected costs, seasonal business cycles, or short-term opportunities.

Commercial Paper

Commercial paper is a money market instrument issued by large corporations to obtain short-term funds from investors. It consists of unsecured promissory notes with maturities up to 270 days.

Here’s how it works:

• A business or corporation wants to raise quick financing for operations, expenses, or short-term needs.

• They issue commercial paper through a dealer or underwriter, offering an attractive interest rate and short repayment timeline to investors.

• Investors like money market mutual funds purchase the commercial paper to earn more interest than standard investments like certificates of deposit.

• After a few weeks or months, the company pays back the face value of the commercial paper plus interest.

Commercial paper offers companies a quick way to borrow that’s more affordable than bank loans. For investors, it provides relatively safe, short-term returns above basic savings or money market rates.

Only firms with strong credit and financials can issue commercial paper. It’s predominantly used by major corporations, financial institutions, and industrial businesses that require extensive funding for daily operations. Companies must have commercial paper rated by credit services like Standard & Poor’s or Moody’s Investors Service to attract investors.

Key Benefits of Unsecured Short-Term Loans

These three major types of unsecured short-term loans offer unique advantages:

• Speed – Funding can be accessed quickly, often within days or weeks. This supports immediate and unexpected business needs.

• Flexibility – Borrowing limits can be tailored and adjusted as business requirements change.

• Simplicity – Qualification and application processes are generally straightforward compared to long-term loans.

• Affordability – Lower amounts and shorter repayment terms make these loans relatively affordable.

• Unsecured – No collateral is required, so businesses don’t need to tie up valuable assets.

Use Cases and Applications

Unsecured short-term loans serve many common business purposes:

• Covering operating expenses and inventory purchases
• Managing cash flow gaps
• Financing temporary increases in production
• Funding special short-term projects
• Bridging delays in client payments
• Handling unexpected expenses or emergencies
• Taking advantage of special purchase order or pricing deals
• Expanding marketing and advertising temporarily
• Providing additional working capital before securing longer-term financing

Nearly any business can benefit from unsecured short-term financing to handle immediate capital needs flexibly and affordably.

Risks and Downsides

While useful, unsecured short-term loans do come with some risks and disadvantages to consider:

• Higher interest rates than long-term, secured debt
• Large repayments can strain cash flow
• Ongoing access depends on maintaining good credit
• Chance of non-renewal after term expires
• Strict requirements and covenants from some lenders
• Excessive use can indicate a business has deeper issues

For companies with poor credit or unsteady finances, these loans may be difficult to qualify for. Borrowers need to have a reliable plan for repayment within the loan’s term.

Tips for Securing and Managing Short-Term Business Loans

When exploring short-term unsecured financing, keep these tips in mind:

• Have a solid business credit profile and financial history. This makes qualification easier.

• Understand the true cost with interest rates, fees, and terms. Compare options.

• Match loan duration to how long funds are needed. Don’t take unneeded long terms.

• Get agreements in writing. Read terms, covenants, and repayment details closely.

• Automate repayments from business accounts to avoid missing payments.

• Use funds only for stated business purposes, not personal expenses.

• Build repayment into cash flow forecasts and budgets. Don’t overextend.

• Communicate regularly with lenders. Keep them updated on business financials.

• Explore renewing or extending terms in advance if repayment may be an issue.

Trade credit, bank loans, and commercial paper provide versatile unsecured financing businesses can access quickly to fund short-term needs. Their flexible terms and unsecured nature fill an important niche, though borrowers need to manage repayment carefully. With strong credit and financials, unsecured short-term loans offer an affordable way to smooth out cash flow, handle unexpected expenses, and take advantage of opportunities.