Personal Loans – Short vs Long Terms
When considering a personal loan, the length of the term is just one thing to consider. But how does it impact your finances, and is there really much of a difference? We explore the key considerations of short versus longer repayment terms so you can make informed decisions and wise financial choices.
Loan Term Options
Most personal loans have repayment terms from 12 to 60 months, and installment loans are often from 6 to 24 months. Some lenders might have different options, but these are the more common terms available.
Cost of Borrowing
The interest rate or APR is often one of the first things many people will look at when reviewing personal or installment loans in Canada to get an idea of what it might cost to borrow from a lender, but it’s not the only factor to consider. A longer loan term can reduce the cost of your monthly payments, but usually increases the cost of borrowing overall. This means you’re paying more interest when choosing a longer loan term.
With some lenders, the length of the term also affects the interest rate you might be provided, which is another way a long term loan can increase the cost of borrowing. With banks increasing eligibility requirements and minimum credit scores to get personal loans, more people look to online lenders vs banks as an alternative option.
Pros and Cons of Short vs Long Term Loans
There’s a number of factors to consider that might not be obvious when weighing the difference between a short versus a long term for a loan. In the following analysis this comparison is about the repayment terms of personal loans and installment loans, not short term payday loans.
Pros of short-term loans
- Overall cost is lower
- Quick access to funds
- Rate are possibly lower
- May get out of debt sooner
Cons of short-term loans
- Monthly payments are higher
- Limit to amount you can borrow
- Can create debt problems if mismanaged
- Might require lower debt-to-income ratio (DTI) to qualify
Pros of long-term loans
- Monthly payments are lower
- Less impact on your budget
- Possibly easier to qualify for
- Larger amount to borrow
Cons of long-term loans
- Remain in debt longer
- Overall cost to borrow is more
- Likely increases debt-to-income ratio (DTI)
- Higher DTI may affect ability to get other loan products
Overall, a short repayment term costs less in interest, and longer is easier on the budget. But a longer term loan can also be more challenging to qualify for.
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Choosing the Right Option
When trying to decide whether a loan with a short term or longer term is the right option for you, it can come down to a couple of things to consider.
If you are in a position where you can afford higher monthly payments and prefer not to pay more in interest, a shorter term is probably the right choice.
But if you have a tighter budget and need a solution where lower monthly payments are important, then a longer term for your loan might be the option for you.
If you were to take a personal loan of $5,000 at an 11% interest rate:
2 year term – your monthly payment is about $233
5 year term – your monthly payment is about $109
The overall cost of borrowing (with 5% origination fee) would look like this:
2 year term – $842.94
5 year term – $1,772.73
The difference in cost of borrowing would be about 110% overall.
Choosing the right option when it comes to short versus a longer term loan often comes down to priorities, what you can afford, and what your financial plans might be.
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What to use a Personal Loan for
A personal loan is an unsecured loan that doesn’t require collateral that you can usually use for anything you choose. Many choose to use it as a debt consolidation loan, while others might use it for a big purchase, travel or a variety of other options. It’s important that you are comfortable with carrying the debt and able to make the payments as it can affect your credit score and it would be your responsibility for a considerable amount of time to do so. You want to make sure you’re doing it for all the right reasons and not bad ones when getting a loan.
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Personal loans are one option, and usually what most people choose when they need or have plans that require borrowing. Some alternatives can include borrowing from friends or family, using credit cards, using a home equity loan or line of credit, or borrowing from your RRSP.
Another option if you don’t want to borrow is to examine what items you have of value that you might be able to sell in order to avoid months or years of scheduled payments and debt.
Getting a shorter term for your loan may cost you less, but a longer term might fit with your budget. Ultimately, you have to look at what’s right for your own financial situation.