The term of a loan refers to the length of time you have to repay the loan. This is one of the most important factors to consider when taking out a loan as it impacts your monthly payments total interest costs, and overall affordability. In this comprehensive guide, we’ll explain everything you need to know about loan terms so you can make an informed borrowing decision.
How Loan Terms Work
When you take out a loan from a lender like a bank, credit union, or online lender, you agree to repay the money over a set period of time. This repayment period is called the loan term.
Common loan terms include:
- 15-year mortgage
- 30-year mortgage
- 3-year auto loan
- 5-year auto loan
- 10-year student loan
- 15-year student loan
- 3-year personal loan
- 5-year personal loan
The term always relates to the length of time you have to repay the loan. Longer terms mean you have more time to pay back the money, while shorter terms give you less time.
When reviewing loan offers, pay close attention to the term being offered Lenders may give you different term options to choose from, so you’ll want to select the one that best fits your budget and financial goals
How Loan Term Length Impacts Costs
The length of your loan term significantly affects your borrowing costs. The main factors influenced by the term are:
Monthly Payment
Loans with longer terms generally have lower monthly payments because the payments are spread out over more months.
For example, on a $200,000 mortgage:
- A 15-year term would have monthly payments around $1,500
- A 30-year term would have monthly payments around $1,000
While the lower monthly payment on the 30-year term seems attractive, keep in mind you’d pay more interest overall because you’re borrowing for twice as long.
Interest Rate
Lenders often offer lower interest rates for shorter term loans to compensate for the higher monthly payment.
Using the mortgage example again:
- A 15-year mortgage may have a 3% interest rate
- A 30-year mortgage may have a 3.5% interest rate
So the shorter term gets a discount on the interest rate.
Total Interest Cost
Since you pay interest on the loan balance each month, the longer you take to repay, the more interest you pay.
On that $200,000 mortgage:
- The 15-year term would accumulate around $94,000 in interest
- The 30-year term would accumulate around $186,000 in interest
So you’d pay almost double the interest by going with the longer 30-year term. Keep this in mind when choosing a term.
How to Choose the Right Loan Term
Choosing the right loan term involves weighing several factors:
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Affordability – Can you handle the monthly payment on a shorter term? Make sure to budget carefully.
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Interest savings – Do you want to pay less interest overall? Shorter terms can help.
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Payoff goal – Do you hope to pay off the loan quickly? A shorter term would achieve that.
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Flexibility – Do you want flexibility with your monthly budget? A longer term provides that.
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Risk tolerance – Are you comfortable committing to higher payments for a short time period? Or would you rather have a lower payment for longer?
You’ll also need to consider the type of loan, as terms can vary:
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Mortgages – Typically 15 or 30 years. Go with 15 if you can afford the higher payment.
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Auto loans – Usually 3 to 6 years. Don’t stretch longer than 5 years to keep interest costs down.
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Personal loans – Normally 2 to 5 years. Shorter is better if you can manage the payment.
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Student loans – Standard is 10 years. Extend only if necessary to afford the monthly payment.
Think about your financial situation carefully in choosing the loan term. The general rule is go with the shortest term you can reasonably afford. This saves on interest costs in the long run. But don’t go too short on the term where you’ll be stuck with an unaffordable payment. Find the right balance for your unique situation.
Tips for Getting the Best Loan Term
Here are some tips to help you get the best loan term when borrowing:
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Check your credit – A good credit score qualifies you for better terms from lenders.
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Compare offers – Apply with multiple lenders to find the best loan terms.
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Negotiate – See if the lender can reduce the rate for a shorter term.
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Make a larger down payment – Putting more money down can help qualify for a shorter term.
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Pay more each month – Paying extra monthly helps pay off the loan faster.
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Refinance later – After improving your credit, you may be able to refinance for a shorter term.
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Avoid fees – Fees and charges add to your total borrowing costs.
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Understand the lender’s terms – Read the fine print so you know what you’re agreeing to.
The most important things are to shop around, negotiate the best deal possible, and understand how the term impacts your financial situation. With the right loan term, you can keep costs low and pay off your loan faster.
Frequently Asked Questions
What is a typical auto loan term?
Auto loans typically have terms ranging from 3 years to 6 years. Some lenders may offer longer terms up to 7 or 8 years, but it’s best to keep the term at 5 years or less to save on interest charges. Aim for a 3 or 4 year term if you can afford the higher monthly payment.
What is the average student loan term?
The standard repayment term for federal student loans is 10 years. This applies to direct loans and FFEL program loans. Some federal consolidation loans allow terms up to 30 years. Private student loans vary but many have 10-year terms.
Can I pay off my loan faster than the original term?
Yes, most loans allow you to pay more than the monthly amount or pay off the full balance early without penalty. This allows you to pay off the loan faster than the original term if you wish. Paying extra can save you money on interest.
What happens if I pay off a loan early?
When you pay off a loan early, you simply won’t have to make any more monthly payments once the loan balance reaches zero. You also stop accruing interest on the loan. Paying off early saves you the interest you would have paid over the remainder of the term.
Can lenders change the loan term later?
No, the loan term is part of the binding agreement made when you originally took out the loan. The lender cannot unilaterally change the length of the term later on. You would have to agree to refinance the loan to change the remaining term.
The Bottom Line
The term of your loan has a big impact on what the loan will cost as well as the monthly payment. Be sure to choose a term length that balances your interest cost savings with an affordable payment for your budget. Evaluate both the payment and total interest charges when comparing term options for any type of loan.
Understanding Loan Terms
When lenders make loans to borrowers—whether it’s a mortgage loan, personal loan, car loan, or any other type of loan—it’s under certain conditions and guidelines. These guidelines for borrowing are spelled out in the loan terms, and they detail what’s expected of both the borrower and the lender. Loan terms are typically included in the final loan or credit agreement.
Reviewing loan terms before signing off on a loan is important for several reasons. First, you need to know what your obligations are with regard to making payments on the loan. If your loan payment is due on a specific date each month, for example, you would need to know that to avoid paying late and potentially damaging your credit score.
Understanding the loan terms can also help you to determine whether a loan is a good fit for you before you enter into a repayment agreement with the lender. If there’s something in the loan terms with which you don’t agree—such as a penalty fee or another condition—you could reject the loan offer.
Loan terms can vary considerably. What you agree to for a car loan, for instance, may be very different compared with the terms required for a personal loan or mortgage, and there may be terms included that are specific to the type of loan involved.
Loan Repayment Period
The first loan term to get familiar with is the loan repayment period. This means how long you’ll have to repay what you borrow. For example, if you’re getting a mortgage, your loan might have a 30-year term, meaning your payments are spread out over a 30-year period. A car loan, on the other hand, might have a five-year term, while federal student loans have a standard 10-year repayment term (except for consolidation loans, which can have terms from 10 to 30 years).
Loan repayment periods are typically broken down into an amortization schedule. This schedule shows you how your payments are applied to your loan balance over time. Typically, this will detail:
- How much of each payment goes to principal
- How much of each payment goes to the interest
- How your principal balance decreases over time
- The total amount of interest paid over time
The longer your loan repayment period, the lower your monthly payment may be, but a longer loan repayment period can also translate to more interest paid in total over the life of the loan. For this reason, it might be wise to first use a personal loan calculator to determine how a shorter term will affect the overall cost of the loan.