What is the loan term?

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The loan term represents the period of time in which the loan is in force and is expected to be repaid. The loan term’s expiration is often called the loan’s maturity date. The loan term is one of the four basic components of a loan, which includes the interest rate, the principal or amount borrowed and the monthly payment.

When there is an established loan term, as is the case with all installment debts, the loan term is part of the original loan agreement between the lender and the borrower. By comparison, revolving debts usually do not have any loan terms.

Loan terms can vary in length from one week to 30 years or more, depending upon the type of the loan. Shorter loan terms are typical for payday loans where full repayment of the loan is expected in as little as one week, as well as for many personal loan programs, which typically offer loan terms between three months to three years. Longer term loans typify home mortgage loans where repayment is expected over the course of 10, 15 30 and even 40 years. In between, you have automobile loan terms, which are normally between three to five years in length.

Effect of loan term on loan payments

For loan borrowers, the biggest impact imposed by the loan term is felt on the monthly payment. Assuming that the amount borrowed and the interest rate remain the same, lengthening or shortening the loan term the payments will force the monthly payments to dramatically rise or fall.

For example, a $100,000 loan amount with eight percent interest over 20 years results in a monthly payment of $836.44. If that same loan adjusted the loan term to 10 years, the monthly payment would rise to $1,213.28. Similarly, lengthening the loan term to 30 years lowers the monthly payment to $733.76.

Longer loan terms will also increase the amount of interest charges that a borrower pays over the period of the loan. In the instance of a $20,000 automobile loan at eight percent over six years the monthly payment is $350.66. Over that six-year period, the interest charges paid to the lender would total about $5,247.87. However, using that same loan and shortening the term to four years, the monthly payment rises to $488.26. More importantly, the total interest charges during that shorter four-year period would total only $3,436.41 in interest going to the lender.

Depending on the lender, a loan term may be negotiated between the borrower and the lender or the loan term can be non-negotiable. For example, many personal loan providers often provide the approved borrower with a loan term range. The borrower can then select a loan term within that range for the final loan agreement. Loan term considerations often come down between two competing priorities for borrowers:

  • Paying off debts as quickly as possible.
  • Keeping installment payment amounts as low as possible.

Unfortunately, those two priorities don’t always play well with each other, and it’s up to the borrower to determine which is really most important. For many borrowers, the ideal loan term comes down to the highest payment the borrower feels most comfortable budgeting and the least amount of interest that borrower will have to pay to the lender over the life of the loan.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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