Getting a personal loan can be helpful when you are planning a big purchase. When you get a personal loan with longer repayment terms it can lower your monthly payments.
But what if you took a personal loan not long ago and find it difficult to make the payments each month. One option would be to take another loan to pay off the first loan, but with a longer term so that the monthly payments are lower.
Taking a loan to pay off another can sound strange to some, but it’s done all the time. Often referred to as a debt consolidation loan, some will do this when they have loans or credit card debt, and qualify for loans with lower interest rates. While you should look at more than just the interest rate or APR, when you get a lower rate you often come out ahead.
RELATED: Personal Loans – Short vs Long Terms
You should know that when it comes to borrowing a long term means that you are paying more in interest overall. The longer the term, the more interest you’ll pay. This is the cost of borrowing, and lenders charge more for longer terms since it’s an increased risk to them when the money has a longer term to pay back what is owed.
Whatever the length of time to repay or term you choose, it’s wise to be on the lookout for a loan that does not have a prepayment penalty. Not only so you have the option to pay off the loan anytime that works for you, but also the option of making extra payments when you can. Which can help you to pay it off sooner and allow you to do other things with your money.
Many personal loans will allow lenders up to 60 months (5 years) for their repayment terms, with some lenders offering even longer. If you apply for an installment loan it is more likely to be anywhere from a few months to a couple years long for the terms. When looking at the terms, one thing you want is a loan with a fixed rate. Especially these days, with inflation being what it is.
Advantages of long term loans include:
– keep making your loan payments on time and it can help build your credit score
– longer terms mean lower monthly costs, so you don’t live paycheque to paycheque
– with a longer term, getting a larger amount is sometimes more possible
Disadvantages of long term loans include:
– longer term loans cost more (in interest) to borrow
– longer term loans also tend to put a financial strain for a longer period
– your debt to income ratio increases, making it difficult to get other credit products
Other details about the loan that you should know is there could be other fees in addition to a prepayment penalty. The good news is that any fees or penalties must be disclosed in the loan agreement, which must be presented to you before signing.
If you were to take a personal loan of $5,000 with an interest rate of 12%, the following scenarios provide an idea of how the cost of borrowing varies, and how you can lower your monthly payment with longer terms.
Scenario 1 – 2 year term
Total interest: $649
Monthly cost: $235
Scenario 2 – 5 year term
Total interest: $1,673
Monthly cost: $111
As you can see from above with a longer loan term, the total interest is more than double, but the monthly payments are below half. Only you can decide whether paying less per month or less interest overall is the right option. But if you find money is tight each month, getting a longer loan term might make sense for your own situation.