Thinking about taking out a loan but unsure about short-term vs. long-term loans?
Short-term loans and long-term loans both come with their own set of pros and cons. And depending on your needs, one option may work better for you than the other. In addition to the loan length, there are other important factors to look into when considering your new loan product.
Advantages and Disadvantages of Short-term Loans
A short-term loan is typically between a few months up to about a year. Short-term loans work best for minor emergencies, but a short-term loan can be for a larger expense depending on your income and ability to repay the loan.
A few examples of short-term loans include installment loans, cash advance loans for bad credit, payday loans, and other personal loans which can be used for a variety of small expenses.
Here are the main advantages short-term loans tend to come with:
Potential of Paying Less Interest
With a shorter loan period, you may be paying less interest on the loan since there will be fewer monthly payments. Because interest can be the most expensive cost when borrowing, you could be saving a good amount of money with your loan.
Getting the Loan Off Your Credit Report Faster
When you take out a loan, it will appear on your credit report. And depending on your debt-to-income ratio, having another loan on your credit record can harm it. However, because you can pay off shorter loans quicker, it may not affect your credit for very long. Find out more about how your credit score is calculated and how loans can impact it, before signing up for funding.
An Easy Way To Build Your Credit
Building credit involves having a balanced portfolio. If you don’t have any credit history or are trying to improve your credit score, a short-term loan can help. On-time payments with a short-term loan and eventually paying off the loan can help you with your credit report.
Ease of Accessibility and a Variety of Uses
Short-term loans make funding reasonably straightforward, as there are tons of online lenders out there. The application process and eligibility requirements are pretty flexible compared to long-term loans. Additionally, you can use the funds from a short-term loan for various expenses. And so, these loan terms work best for a personal financial situation.
A few disadvantages that can come with short-term loans:
Limited Loan Amount
Short-term loans usually offer between a few hundred and a few thousand dollars in funding. This amount of money may not be enough for the expense you are looking to take care of with your loan. And so, checking out longer-term borrowing options may make more sense.
Fixed Interest Rate
In most cases, short-term loans come with a fixed interest rate. Depending on your credit score this can be either good or bad. If you have poor credit the interest rate will be higher and stay that way through the whole loan period. Whereas with longer loans that usually come with a variable interest rate—can change to reflect any positive moves you make on your credit score.
Higher Monthly Payments
A shorter loan term financing can mean higher monthly payments (when borrowing the same amount of funds with a more extended repayment period).
Work Well Only for Short-term Emergencies
Short-term loans are best for unexpected emergencies rather than a long-term financial goal or plan. And so, although you can use them for a variety of expenses, they may not be the right option for certain expenses.
Pros and Cons of Long-term Loans
Long-term loans are typically anywhere from a year up to several years. These loans are usually used for large purchases or goals. Examples of long-term loans include a Mortgage loan, a small business loan (SBA loan), or a car loan. Here are some of the benefits you could get with long-term loans:
More Money To Spend
Long-term loan amounts are usually much more significant than short-term loans. And so, if you are looking to make a large purchase like a home or need funds for a startup, a long-term loan may make more sense.
Easier To Pay off With Limited Monthly Income
longer period loans tend to have lower monthly payments. And so, if you don’t have a steady cash flow coming in, this type of loan could be more affordable than short-term funding options.
A Long-Term Loan is Usually a Better Option for Small Businesses
Long-term loans are generally best for those starting a business and have costs to support. A long-term loan can cover the various startup costs that most small businesses must take on to get their business off the ground. These loans are best for new businesses because they could offer a large amount of funding, which is crucial to launching a business.
Below are a few disadvantages that can come with a long-term loan:
Paying More Interest
Although long-term financing means a lower monthly payment and flexible repayment schedule, a long-term loan can also mean paying more interest over time.
Eligibility Requirements are More Thorough
A long-term loan poses more risk to lenders. Because of this, if you don’t have good credit or can’t meet the minimum income requirement, you will not be approved for the loan.
Can Lead to a Long-term Cycle of Debt
Having years of loan payments is a huge responsibility to take on. If something unexpected happens and your cash flow changes, your loan payments will still need to be paid. This long debt period can lead to even more debt if something changes with your money—definitely, something to think about with a longer loan term.
Other Factors in Addition to a Short-term Loan vs. Long-term Loan to Consider
It would help if you considered how long or short your loan is when deciding on a loan program to go with. In addition to a repayment schedule, there are other essential factors to pay attention to:
The Repayment Terms
The loan repayment terms will encompass everything from the amount due every month to any fees associated with the loan. It is crucial to know the details of the loan terms before you take it out. Ask about the interest rate in terms of APR and MPR. Consider how much extra money you are paying on top of the principal and interest rate. When working with a variable interest rate (regardless of the type of loan), be sure to ask about maximums on interest rates and any introductory interest periods.
The Value of the Loan
It is important to think about the amount of money you are getting in ratio to the interest rate. For example, you may be getting lower interest rates with a lender. Still, the money you are getting may be higher in interest percentage than if you were to get a higher interest rate for a larger amount of funds.
And so, learn how to calculate interest on a loan in cash terms to figure out exactly how much you are paying for the amount you are borrowing. More money with more interest does not always mean you will pay more for a loan!
The Lender
Whether you have a short-term or long-term loan, filtering through lenders for financing is always a good idea. Different lenders offer different lending and repayment terms which can mean a lower interest rate and better loan terms. Before choosing a lender to work with, check out past customer reviews and the reputability of the lender.
A short-term loan and a long-term loan come with their sets of pros, cons, and best uses. Before deciding on the loan terms, you need, think about why you are using the loan and whether you can comfortably repay it. In addition to loan length, there are a few essential factors about the loan to consider. The repayment terms, the value of the loan, and the lender are all critical factors that will determine the quality of a loan you are taking out.
For more resources, check out our blog on what to know about short term loans!
