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What is a Short Term Loan and How Do They Work?

Considering a short term loan but not sure if it is right for you? Our guide gives you the introduction and guidance you need to make an informed decision.

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Ever wondered what a short term loan is and how it works? Our guide to short term loans is a great introduction to the ins and outs of these popular loans. Learn more about this type of credit and what it involves, from its common uses to its potential impact on your credit score.

Also known as a payday loan, cash loan or a small amount loan, a short term loan is a type of credit that allows small amounts of money, generally up to $2,000, to be borrowed. These loans are short-term in nature and typically have a loan term of between 16 days and 12 months. They are designed to provide the borrower with the cash they require ahead of their next payday.

Short term loans are a form of credit that can be accessed with many different uses in mind. It is often used to cover unexpected expenses, such as medical expenses, costly car repairs or forgotten bills, but can also be used at the borrower’s discretion. Without firm guidelines on what the borrowed sum can and can’t be used for, some borrowers can find themselves in financial difficulty as they struggle to pay off unnecessary purchases.

The eligibility criteria for short term loans will vary between lenders but it is often less comprehensive than the eligibility criteria for standard personal loans. The minimum criteria for a short term loan will generally require applicants to be over the age of 18, be an Australian citizen or resident, and have a source of regular income. Documentation, such as several forms of ID, bank statements and payslips, is often required to prove that the applicant meets the lender’s criteria.

Short term loans are typically unsecured, meaning that a form of collateral is not used as security against the sum borrowed. As unsecured loans pose a greater risk to lenders, many short term loan lenders charge high fees, including establishment fees, monthly service fees, default fees and missed payment fees, to help recoup their costs.

If you decide to take out several short term loans at one time or fail to meet your repayment obligations, your credit score could be negatively impacted. Some lenders may also be hesitant to lend you money in the future if your credit report features several short term loan enquiries or active short term loans.

If, on the other hand, you do pay off the full amount borrowed within the original loan term, the good credit habits that you demonstrate may have a positive effect on your credit score. It’s important to remember that short term loans shouldn’t be taken out for the sole purpose of building your credit score. There are more sustainable ways to do so.

To access a short term loan, you’ll first need to be approved by the lender. Unlike approval for a traditional loan, getting approved for a short term loan can be quite a quick process. Lenders will typically ask a few questions about your sources of income and employment status to determine how much money they are willing to lend. From here, your application will either be accepted or rejected, often in a matter of minutes.

If your application is approved, you’ll be required to sign a contract agreeing to the terms of the loan and a repayment method, such as a direct debit, will be set up. After the paperwork has been completed, you’ll receive the amount being loaned to you as cash, a cheque or a bank deposit. Throughout the loan term, you will be required to meet all repayment obligations or you will be charged additional fees by the lender.

Short term loans are an expensive option in the world of money lending, with most people repaying far more than they originally borrowed. In Australia, short term loan lenders are not permitted to charge interest on the money that they lend but can charge various fees, including:

  • Establishment fees (capped at 20% of the loan principal)
  • Monthly account fees (capped at 4% of the loan principal)
  • Late or missed payment fees
  • Default fees (capped at double the loan principal)
  • Enforcement fees
  • Statement fees

If you are considering taking out a short term loan, be sure to familiarise yourself with the fees and charges that apply to your loan. Using the information provided to you by the lender, you can work out how much each repayment will be and the regular fees you will be charged. Although you may be able to afford to pay off the principal, once all the extra fees and charges are added, it may not be a realistic option for you.

Short term loans don’t have a great reputation and it can be difficult for some people to stay on top of their repayments. If you’re finding that you’re unable to pay an unexpected expense on time or are facing financial hardship, the best thing to do is to discuss your options with the company or organisation you are dealing with. Many service providers, such as utility companies and phone companies, can work with you to create a payment plan or defer the payment for a specific period of time.

Although it may be a long-term financial commitment, a personal loan could be another alternative to a short term loan if you are needing to borrow a sum of money. They do still require the payment of interest and some fees, but they generally end up being a lot lower than the charges accompanying their short term loan counterparts. It’s worth noting that applying for a personal loan from a bank or another lender may be more difficult, especially if you don’t have a great credit history.

If you have a regular income and are normally quite good with your finances, a credit card may also be an option to consider. Interest and fees do apply, but you are able to pay off a balance over several months or years. This form of credit can be difficult to manage if you aren’t careful, so be sure to research the pros and cons of credit cards before making a decision.

If you decide that a short term loan is the best option for you and your current circumstances, it’s important to always compare the offerings and the total costs involved. At ClearScore, we have a variety of short term loans with rates tailored to your credit score. Check them out and see if any short term loans are right for you.

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