GUAPIFY ORIGINALS

Grasping the link between loan term and credit cost is invaluable.

When you take out a loan, you usually end up paying back more than what you borrowed. That extra amount is called the cost of credit. The cost of credit has the interest the lender charges, as well as any additional fees such as processing charges, insurance, or penalties under its umbrella. 

One key factor that affects how much you’ll repay in total is the loan term, which is the length of time you’re given to pay back the loan in full.

Let’s examine how it works.

Longer Terms Mean Paying in Total

A longer loan term spreads your payments out across more months or years. This usually makes your monthly payments smaller, which can be helpful if you’re working with a tight budget. 

Nonetheless, there is a price to pay. In the sense that the more time you take to repay a loan, the more interest adds up. So even if the monthly payment is lower, you end up paying more in total.

For instance, let’s say you take out a $10,000 loan with a 6% interest rate. Your monthly payment would be approximately $131 if you decide on an 8-year repayment plan. Although that might seem doable, you will have paid roughly $2,615 in interest alone by the end of the term (not including any additional fees the lender may impose).

Shorter Terms Usually Cost Less Overall

You will definitely pay off the loan more quickly if the loan term is shorter. The total amount you repay is typically less, but your monthly payments are typically higher. Over time, you save money because interest has less time to accumulate.

Let’s return to the earlier example. If you borrow $10,000 at 6% interest and choose a 3-year term instead of 8, your monthly payment would jump to about $304. That’s more than double the payment for the 8-year loan, but the total interest paid would drop to about $951. That’s a savings of over $1,600.

Some lenders also offer lower interest rates for shorter terms, since they get their money back faster and take on less risk.

How to Choose the Right Term For You

There’s a range of loan terms, and one is the right fit for you.

Your income, expenses, and financial goals will determine the ideal loan term for you.

A longer term might be simpler to handle if you require smaller monthly payments to maintain your financial stability. However, a shorter term might save you more money overall if your budget can accommodate larger payments.

So, compare the monthly payments and the total cost of repayment before making a decision. You can use a loan calculator to see how the numbers add up and find the best option for your circumstances.