There are many phrases that sound extremely similar but have nuanced meanings. The phrase âloan termsâ can cause some confusion because itâs often used to refer to multiple aspects of your mortgage.
If youâre feeling overwhelmed, thereâs no need to worry. A loan term can easily be understood with the right guidance and definition. Letâs break it all down.
The loan period refers to the amount of time you have to repay a loan It starts when you take out the loan and makes the first payment, and ends when you make the final payment that pays off the remaining balance. Understanding the loan period is important for borrowers so they know how long they will be paying back the money they owe
How the Loan Period is Determined
Several key factors go into determining the length of the loan period:
-
Principal amount The amount of money borrowed. The higher the principal the longer it may take to repay it.
-
Minimum payment The lowest payment allowed each month This is usually a percentage of the outstanding balance
-
Interest rate: The rate charged on unpaid principal each month. Higher rates mean more of your payment goes toward interest.
-
Maximum payment: Some loans allow you to pay more than the minimum to pay down the balance faster.
When you apply for a loan, the lender will use these details to create an amortization schedule showing exactly how long it will take to repay the loan making regular payments. They ensure the payments are high enough to pay off the full balance by the end of the loan period.
Typical Loan Periods
Loan periods can range from a few months to several decades depending on the type of loan:
- Mortgages: Usually 15-30 years
- Auto loans: 2-7 years
- Personal loans: 1-7 years
- Student loans: 10-25 years
- Payday loans: 2-4 weeks
Longer loan periods mean lower monthly payments, but higher total interest paid over the life of the loan. Short loan periods have higher monthly payments, but you pay off the balance faster and pay less interest overall.
How the Loan Period Affects Interest and Payments
The loan period directly impacts your monthly payments and total interest costs:
- Longer loan period: Lower monthly payments, higher total interest
- Shorter loan period: Higher monthly payments, lower total interest
This is because when the loan period is longer, the principal balance you borrowed is spread out over more months. Each payment doesn’t reduce the principal as quickly. More of your payment goes toward interest charges rather than actual debt repayment.
For example, borrowing $20,000 over 2 years costs much less in interest than borrowing the same amount over 7 years. The monthly payment is higher with the shorter 2-year loan, but you save significantly in interest and pay off the loan faster.
Should You Choose a Short or Long Loan Period?
In most cases, shorter loan periods are better to minimize expensive interest charges. But you need to make sure the monthly payments fit comfortably within your budget.
Consider a 5-year auto loan versus a 7-year loan for the same vehicle. The 5-year option will have higher monthly payments, but you might save thousands in interest. Make sure the 5-year payment is affordable for your budget.
Also note some loans charge prepayment penalties if you pay off the balance early. A longer loan period can provide flexibility in case you want to make extra payments some months.
Adjusting the Loan Period
In some cases, you may be able to adjust the original loan period:
-
Refinancing: Get a new loan with different terms, including a different period.
-
Paying early: Make extra payments to pay off the loan faster than scheduled.
-
Paying late: Missing payments can extend the loan period.
-
Deferment/forbearance: Temporarily pause payments on some loans like student loans.
Refinancing or intentionally paying early are the best ways to reduce an existing loan’s period. Paying late or postponing payments will end up costing you more interest in the long run.
Loan Period vs Term
The loan period is different than the loan term:
- Loan period = The full time you have to repay the loan
- Loan term = Details of the loan like interest rate, fees, etc.
However, “term” is sometimes also used to refer to the loan period specifically. For example, a “5-year term” means the loan period is 5 years.
Tips for Managing the Loan Period
Follow these tips to make the most of your loan’s repayment period:
-
Carefully review the loan period, payments, interest rate, and other terms before accepting a loan.
-
Try to pay off debt as fast as you can afford to by paying more than the minimum payment.
-
Be cautious about very long loan periods which cost much more in interest.
-
Avoid adjusting the loan period by paying late or postponing payments if possible.
-
Refinance high-interest debt to get a shorter loan period and lower rate.
-
Use loan calculators to model how different loan periods impact your total costs.
Common Questions about Loan Periods
How is the loan period calculated?
The lender calculates the loan period based on the amount borrowed, the interest rate, and the minimum monthly payment. The period continues until the monthly payments pay off the entire original principal balance plus all accrued interest.
Can I pay off my loan early?
Most loans allow early payoff without penalty. But some, like mortgages, may charge a fee for paying off the loan before the end of the period in the contract. Check with your lender.
What happens if I pay late?
Paying late extends the loan period because you will owe interest on the late payment amount. Late fees are also common. Missed payments can negatively impact your credit score as well.
Who determines the loan period?
The lender establishes the loan period upfront when they prepare the loan agreement. But it must be agreed to by the borrower in order to proceed with the loan.
Can I extend my loan period?
You may be able to extend the loan period through deferment or forbearance if you have trouble making payments, such as with federal student loans. This postpones payments but interest still accrues, increasing your total costs.
The Bottom Line
The loan period is a critical detail that borrowers should review closely before taking out a loan. In general, shorter loan periods allow you to pay off debt faster and save on interest charges. Just be sure the monthly payment fits comfortably in your budget. Carefully manage the loan period and make payments on time or early whenever possible.
The Bottom Line: Itâs Important To Learn What A Loan Term Means
Donât let a little jargon get in the way of understanding your loan documents. Remember that âloan termsâ is just a phrase often used to address the overarching aspects of your mortgage.
You may hear the phrase used to discuss the term of your loan â that is, the length of time you have to repay the borrowed funds â or the terms and conditions associated with borrowing them. Your terms and conditions will tell you all you need to know about the ins and outs of your mortgage, so youâre fully aware of what youâre agreeing to when you sign your contract.
Purchasing a home and obtaining a mortgage are complex processes, and itâs natural to be a little confused by them at first. Weâre here to help you parse through this industry language, identify the information essential to your loan and loan term, and learn everything you need to know about the mortgage loan process.
If youâre ready to move forward with a mortgage, you can .
What Is A Loan Term?
Before we get too deep into loan terms, itâs important to understand what exactly a loan term is. A loan term is defined as the length of the loan, or the length of time it takes for a loan to be paid off completely when the borrower is making regularly scheduled payments.
These loans can either be short-term or long-term, and the time it takes to pay off debt from the loan can be referred to as that loanâs term. All the most common loans will include a term, including student loans, personal loans, auto loans and different types of mortgage loans.
The fact that the phrase âloan termsâ is often used as umbrella language to describe different mortgage-related words is the primary reason why so much confusion exists around this topic. âLoan termâ is just the lingo used to describe the broad aspects of your mortgage. Therefore, depending on the context, it may refer to the lifespan of your loan, or the terms and conditions involved in borrowing funds.
If youâre ever uncertain about anything regarding your mortgage, itâs best to ask your lender to clarify.
To better understand what a loan term is, letâs look at an example. Letâs say you have a 15-year fixed-rate mortgage. The loan term will then be 15 years. During this time, the loan must be paid off or refinanced during the term. Your loan can last for any length of time â it just needs to be agreed upon by the lender and you as the borrower.