The Element Of Time In Loans
Let’s start with the basics.
A loan is an agreement between you and a lender: the lender agrees to loan you a certain amount of money and you agree to repay it each month with interest.
One of the key factors in any loan repayment is the period of the loan - the amount of time you’ll take to pay it down.
- The longer the amount of time you have to repay a loan, the more you’ll pay in interest charges.
- Longer term loans offer lower monthly installments because the loan amount is divided by more months than a short-term loan.
Types Of Short And Long-Term Loans
Payday loans - which come due in less than a month- are probably the shortest-term loans you’ll encounter.
Some personal loans that need to be repaid within 6 months to a year would also fall into the short-term category.
Long term personal loans can be repaid over a period that could stretch up to seven years.
They tend to have higher APRs than short term loans, but they may still be affordable because of their lower monthly installments.
Deciding between a short-term and long-term loan means weighing up the pros and cons of each.
Take a closer look at each to uncover the important details.
Long Term Loans – The Pros and Cons
- Repayable Over A Longer Period – Long-term loans are accompanied by more installments and a lower monthly repayment amount.
- Lower Installment Payments - You’ll have longer to repay your loan and the installment may be more affordable as part of your monthly budget.
- Competitive APRs – Those with a good credit score can secure a relatively low APR.
- More Interest Charges - The interest on your loan is calculated on a monthly basis and more months equals more interest.
- Financial Drain - Having to pay a loan installment for seven years can be a drain on your finances. You may risk defaulting on the loan in an economic downturn or if your personal situation changes.
- Higher APRs – If your credit is less stellar, you’ll probably pay a higher interest rate on your loan.
Short Term Loans – The Pros and Cons
- Lower APRs - Short term loans usually come with lower interest rates than a long-term loan issued to a customer with the same credit score.
- Quicker Repayment - With a loan term of a year or less you’ll be motivated to pay down your loan and get out of debt faster.
- Less Interest - Short term loans have fewer installments in total. That means most of the amount you pay each month goes to reducing the loan amount and not only paying the interest charges.
- Higher Monthly Installments - The flip side of short-term loans is that you have less time to repay them. That pushes your monthly payments higher than they would be on a long-term loan.
- More Stringent Qualification - You may need a higher monthly income to be approved for a short-term loan.
- Harder On Your Budget - You’ll need to allocate a bigger chunk of your monthly income to repaying a short-term loan.
Comparing Long And Short Term Loans
The major differences between short and long-term loans are the repayment period, the monthly installment amount, and the interest you’ll pay over the lifetime of the loan.
Take a look at these three important factors in more detail.
- Monthly installments will be higher on short-term loans and lower on long-term loans. If your budget is a little tight you may want to opt for a long-term loan.
- Interest payments add up each month. That makes short term loans more attractive because you end up paying less in the long run.
- The repayment period is shorter with short-term loans. This can keep your motivation up as you repay the loan. A long-term loan may start to feel like a drain on your finances - or if the installment is small enough you may not notice it after a while.
For example, a $10,000 short term loan repaid over a period of a year at 5% APR will cost you $856 per month.
You’ll end up paying $272 in interest on the loan over the course of the year.
If you had to borrow $10,000 at 15% APR on a long-term loan of seven years your monthly payment would be $237 per month.
That’s way more affordable than the short-term loan.
However, you’d be paying over $4,000 in interest over the seven-year period.
Long-term loans are more affordable but cost more in total when interest payments are taken into account.
How You Can Choose The Right Loan Type For You
By now you’re probably wondering: since short term and long-term loans both have their pros and cons, which one is best for me? Here are a few things to consider when you decide between the two.
- Consider Your Budget - Short term loans make better sense when it comes to interest payments, but they can take a big bite out of your monthly budget. It’s essential to choose a loan that you can comfortably repay each month.
- Know What Kind Of Borrower You Are - If you’re the type of person who likes to sprint toward the finish line you may prefer a short-term loan. If you’re more of a long-distance athlete with a long-term vision, you may benefit from the affordability of a longer-term loan.
By choosing a loan that’s affordable and suits your personality you’ll increase your chances of making your payments on time and repaying your debt successfully.
That will also help protect and help improve your credit score over time with steady repayment.
To wrap up: short term loans offer quick repayment and lower APRs - but they are more expensive on a monthly basis than higher-APR long term loans.
Now that you know the pros and cons of both loan types you can weigh up the options and decide which loan suits your budget and lifestyle.