What Is a Loan Term?
- A loan term is the amount of time over which you agree to repay a loan, as defined in your loan documents.
- Loan terms can vary widely depending on factors including the type of loan and your credit.
- Shorter loan terms can help minimize the amount of interest you pay, but may result in higher monthly payments.
- Longer loan terms, on the other hand, can mean a lower monthly payment, but more total interest.
When you’re applying to borrow money, one of the items you will have to consider is what the loan term will be. A loan term refers to how long you have to repay your loan, and there are pros and cons to both long- and short-term loans.
Here’s what you should know about how loan terms work and why they matter.
How loan terms work
The loan term is the amount of time that you agree to make payments on a loan. For example, if you were to take out a five-year personal loan, you’d agree to make monthly payments for five years, at which point the debt would be repaid.
Unlike revolving debt, such as credit cards, your loan term is typically fixed. Credit cards, on the other hand, generally stay open, provided you keep them in good standing. So if you make the minimum payments, you can continue using the card and spend up to the limit. At the same time, credit card debt can take significantly longer to pay off than a term loan, especially if you pay only the minimum or keep using the card.
Loan terms can range from short (repaid relatively quickly, such as within a few months to a few years) to long (such as 30 years), depending on the type of loan and the agreed-upon term.
When you make a payment during the life of your loan, it is split between principal and interest. And, as you get closer to paying off your loan, more of your payment will go toward paying off the principal.
Example: A $10,000 personal loan at 10% interest
- Three-year term: $323 per month, $1,637 total interest
- Six-year term: $186 per month, $3,392 total interest
You’ll save about $1,755 by paying off your loan three years sooner.
Why your loan term matters
Your loan term can have a real impact on the cost of your loan.
Shorter terms typically mean a higher monthly payment amount, since you have less time to pay off that debt. By opting for a longer term, you can lower your monthly payment amount. However, there is an important caveat here: Longer terms also mean you’ll have higher total interest costs than if you were to pay off the loan faster.
That means the term you choose seriously affects your loan’s affordability.
At the same time, the terms you’re offered may be shaped by your credit. Lenders are more likely to approve borrowers with excellent credit for a longer term because they’re more confident they’ll be able to repay their debts over time. Using a loan calculator can help you figure out what loan terms make sense for you.
While loan terms can vary widely, extra-short loan terms (think: two to four weeks) are typically associated with predatory loans, such as payday loans. Payday loans can come with fees that are equivalent to a triple-digit annual percentage rate (APR). There can also be rollover fees if you can’t repay the loan on time. That can easily lead to a cycle of debt that’s difficult to escape.
Common loan term lengths by loan type
Loan terms can vary depending on the type of loan you take out. Here’s what you might expect to see for five common types of loans:
| Loan type | Typical term lengths | What to know |
|---|---|---|
| Personal loans | 12 to 84 months | Personal loans are flexible loans that can be used for many purposes. Rates are typically fixed. |
| Auto loans | 12 to 96 months | Car loans use the car as collateral. Keep in mind that missing payments may lead to the vehicle being repossessed. |
| Mortgages | 15 to 30 years | Mortgages use the home as collateral. If your down payment is less than 20%, you’ll typically also have to pay private mortgage insurance (PMI). |
| Student loans | 10 to 25 years | Private student loan rates and terms can vary widely, depending on the student or cosigner’s credit. Federal student loan rates are set each year by federal law. |
| Business loans | Three to 300 months | Small business loans can be backed by the Small Business Administration or offered directly through banks. These often require a personal guarantee, meaning you agree to repay the loan even if the business is unable to pay. |
Short-term vs. long-term loans: pros and cons
If you’re weighing a shorter or longer term, there are several key factors to consider:
| Short-term loan | Long-term loan | |
|---|---|---|
| Monthly payment | Leads to a higher monthly payment | Leads to a lower monthly payment |
| Total interest paid | You’ll pay less interest overall | You’ll pay more interest overall |
| Interest rate offered | May provide access to a lower rate | May come with a higher rate |
| Loan approval | May be easier to qualify for since they carry less risk | May be limited to those with excellent credit |
| Ideal for… | Those who want to save the most money | Those who need to control short-term costs |
Frequently asked questions
Not usually. Once you sign your loan documents, you agree to lock in that term until the debt is repaid. If you’re having trouble paying, your lender may be willing to extend your loan term through a process called loan modification. This feature isn’t available with all lenders.
However, if you refinance your debt — which involves taking out another loan to pay off your existing loan — you can access a new loan term. You can also request a new loan term through debt consolidation. This process helps you roll multiple debts into a single new loan, hopefully at a lower rate.
The ideal loan term depends on your circumstances. If you’re looking for a lower monthly payment, you might opt for a longer term. If you want to save as much money on interest as possible, a shorter term could make sense.
Either way, make sure you can afford your monthly payments for the entire loan term. Falling behind can damage your credit and even lead to repossession if your loan is secured by an asset such as a car or home.
It depends on your loan terms. Some loans may have prepayment penalties, which can eat into the potential interest savings of paying off the debt ahead of schedule. Otherwise, however, paying off a loan early can help you save money and free up room in your monthly budget. Be sure to carefully review your loan terms to understand if there are any fees for paying it off early.
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