Term Loans: Types, Features, Pros & Cons Snneha Lukaa April 6, 2019
What is Term Loan?
Term loans are a type of financing in which the amount borrowed is repaid via regular payments over a fixed duration of time. While usually ranging anywhere from one to ten years, certain term loans can also last for longer than ten years. In some cases, customers can opt between a fixed interest rate or a floating interest rate for their term loan. However, most banks and lenders decide the rate of interest, especially in the case of short term loans. Fixed interest rate remains constant throughout the whole term of the loan. Therefore, the borrower will pay interest based on the rate determined at the time of their loan application. It also means that the EMI amount will remain fixed.In comparison, a floating interest rate fluctuates as per the market and economic conditions. This means that the instalment amount will subsequently fluctuate as well. In general, a fixed interest rate is preferred and advisable for long term loans, and borrowers stand to benefit by opting for a floating rate of interest when availing a short term loan.There are, of course, exceptions to this rule. If a borrower is given the choice for selecting an interest rate, it should always be assessed on the basis of current as well as speculated conditions. In this article, we’ll discuss what is term loan in lending and the features of term loan that borrowers need to know about.
Features of Term Loans
Term loans can be differentiated based on the duration of their tenure as short-term and long term loans. A short term loan is a loan having a brief repayment tenure, usually around 3 months up to three years. A loan with a tenure of three years or more is known as a long term loan. Below, we’ll take a look at the advantages, disadvantages, and features of term loans.
Short Term Loans
As mentioned earlier, term loans with a brief repayment tenure of less than one year, up to three years is known as a short term loan. It is important to consider that the interest rate on short term loans is higher than that of other types of loans, and this goes for long term loans as well.When it comes to developed economies, most banks and lenders offer unsecured short term loans that are known as payday loans. These loans come with tenures as low as three or four months. The concept of payday loans is still new in India, although some banks do have the option for existing credit card and loan customers to purchase electronics with short tenures, such as three to six monthsMany banks and lenders provide both secured as well as unsecured short term loans. With short term loans, there is more leniency in terms of regulations, compared to those of other loansBoth individuals and businesses with a requirement of urgent funds can easily get approved due to the fast application process. Additionally, only minimal documents are required and funds are disbursed quicklySome banks and lenders may not conduct a hard credit check on applicants applying for short-term secured loans. What they do carefully scrutinize is the applicant’s income stability and financial capacity to repay the loan,Some banks and lenders are willing to offer short term loans to borrowers with bad credit history. In certain cases, the lender may charge a higher interest rate for these applicants, compared to what the interest rate they might levy for applicants with a good credit score. The factors that are assessed include the salary, monthly average bank balance (MAB), existing outstanding debts, fixed obligations to income ratio (FOIR) and employment history.
Long Term Loans
Long term loans are provided for an extended repayment tenure. In India, term loans with a tenure longer than three years are usually considered as long term loans, while globally, loans with tenures longer than seven years are considered long term loans.Commonly, the maximum tenure for long term loans in India is ten years, although long term loans such as home loans and mortgages have tenures up to 30 years. Home loans, education loans, and vehicle loans are examples of long term loansLong term loans are availed for larger amounts compared to other types of loans. Therefore, individuals who require a substantial amount of funds urgently but are only able to repay it over a long duration can opt for a long term loanInterest rates for long term loans are lower compared to short term loans and other types of loans. However, the higher interest rate is offset by the fact that interest would be paid over a longer time. Therefore, lending larger principals and longer repayment tenures are how banks profit, despite levying a lower interest rate on long term loansThe monthly EMIs for long term loans can easily be accommodated in even tight budgets, since the loan will be repaid over a longer duration. Lower EMIs can be repaid every month during the loan tenure and also reduces the chances of defaultCertain types of long term loans like home loans can qualify for tax benefits and enable the borrower to claim tax rebates. This differs from the type of loan availed, as well as existing tax laws. In this case, only the interest paid on the loan can be claimed for tax rebateSome lenders also offer long term loans on either fixed or floating rates of interest. With long term loans, it’s advisable to opt for a fixed rate of interest since a floating interest rate is subject to the fluctuations of market and economic conditions.Many long term loans in India require some form of security or collateral, since it minimizes risk for the bank or lender. Therefore, most long term loans are usually always secured loans
When deciding which term loan you want to avail, keep in mind the features of term loans. Short term loans are great for individuals who need quick access to a source of funds. On the other hand, long term loans are the best solution for those who need to avail a large amount of cash but can only pay off the loan slowly.