When you can use a large amount of money that your savings won’t cover, many turn to personal loans to help finance their needs.
When taking out a personal loan one of the considerations is the loan term, or the amount of time that you would agree to making scheduled payments to pay off a loan. These fixed monthly installments or payments are affected by the term you select. Here’s what you should know about determining what term is right for you.
When you take a personal loan with longer terms, your monthly payments will be lower overall and might be a better fit for your budget. If at all possible, you want to avoid living paycheque to paycheque with a budget that’s tight. Not only does this make things stressful, but any mishaps, repairs or need for emergency funds can affect your budget and even your credit if you miss payments.
An ideal arrangement would allow you to put money towards your savings or continue building your emergency fund to be on the safe side.Even if you take a longer term on a personal loan, you should look for an option that would allow you to pay it off early if you choose to, without a prepayment penalty.
Choosing a shorter term for a personal loan typically means you will have less interest, but cost more each month, and it’s important that the payments fit within your budget. The shorter the term, the more you’ll save on interest. While practically everyone would prefer to pay the least amount possible when they get an installment loan or personal loan it still needs to fit with their other expenses and budget.
A shorter term results in less interest on the principal amount borrowed, but with the monthly payments being higher many often choose a longer term so that it is more manageable as a monthly expense. Making the right choice for your own situation is often about finding a suitable balance with what you will be able to afford.
If you were to take a $10,000 unsecured personal loan with a 12% interest rate your payments would work out to approximately $471 each month over a 24 month term. If you chose the same amount loan and interest for a 36 month term, your payments would be about $332 per month. That’s a difference of $139 each month. This is not what you would save, but the difference in cost for choosing a shorter term.
To break things down further using the same principal amount and interest rate, a loan over 24 months would have a total interest of $1,298. And a personal loan over 36 months would have a total interest of $1,957. So the difference in interest would be $659 that you save.
Let’s look at the same principal amount ($10,000) and interest rate (12%) over a 5 year term, or 60 months. Your monthly payment would be $222, and over 60 months you would pay $3,346 in interest.
This is the cost of borrowing, and the longer the term the more you pay in interest. But once again, when you are borrowing, one of the main things to consider is how the payments will fit in with your plans and budget. One of the bigger mistakes some make when borrowing is they choose a shorter term so they pay less interest overall, but when it doesn’t fit with your monthly budget you could be one payment away from disaster.
While the amount and term of a personal loan are something you choose, you also have to qualify to get approved, and your credit score is a big part of the process. Other considerations can include whether you’re employed, how much you take home each month, your debt to income ratio and other factors. If you’re not familiar with most of these considerations that lenders will use to determine your creditworthiness it is advised you read up and educate yourself through the articles here at Goodcheddar to learn more.
With almost 50% of Canadians living paycheque to paycheque and about a third have less than a month of savings for emergencies, it can take just one unexpected expense to affect your ability to make your loan payments. The last thing you want to deal with is damage to your credit score as it has a lot to do with the rate you can qualify for when applying for a personal loan in the future.
Now that you understand the basics about personal loan terms, some mistakes to avoid, and how the difference between a short and a long term will affect the amount of interest paid and your monthly payments, it should be easier for you to make a decision that is going to fit your own personal finance situation. Choosing a personal loan term isn’t difficult and really depends on what is going to fit with your own budget in terms of being affordable for monthly payments.
Whether you choose a bank, credit union or online lenders will often be determined by your own research when comparing personal loans to find the one right for you.