Your personal loan tenure is the repayment duration of your loan, which is the period between your loan disbursement and the maturity date. Picking the appropriate loan tenure can mitigate your debt burden and make it easier for you to repay your loan comfortably.
To help you better understand the process, let’s go over the essentials of personal loan tenure selection.
Understanding the impact of loan tenure on monthly payments
To better understand how loan tenure affects monthly payments, let’s say your loan amount is the same regardless of what tenure you choose. In that case, here is how the length of your loan repayment can influence your monthly payments.
Shorter loan tenure
A shorter loan tenure will mean that you have less time to repay the loan. There might also be higher interest rates, which means that each of your monthly payments will cost more.
If you’re struggling with cash flow in the short term, a short loan tenure might not be optimal for you since the immediate financial stress from obtaining the personal loan will be greater.
Longer loan tenure
A longer loan tenure gives you more time to repay your loan. Your monthly payments will cost less since your loan amount is spread across a longer period of repayment.
However, note that a longer loan tenure means that you will end up paying more in interest. The overall cost of taking out a personal loan can be significantly higher if you opt for the maximum loan tenure.
Factors to consider when choosing a loan tenure
Lenders generally allow you to choose the maximum loan tenure, minimum loan tenure, or anything in between the two durations. Here are some of the most important factors to consider when you decide on the tenure for your personal loan.
The monthly payment amount
How much you can afford to put towards loan repayment each month is a critical factor in deciding your personal loan tenure. Consider the cost of installments to see whether you can comfortably pay them each billing cycle.
Total interest you will need to pay
To find out the total interest that needs to be paid over the life of your loan, you can use an online interest calculator. The length of your loan can dramatically affect how much total interest is paid during your loan tenure.
Your financial goals and obligations
If you have other financial goals (like a large purchase you’re saving up for), keep them in mind while you choose a loan tenure. A shorter loan tenure will likely disrupt your other financial goals in the short term because of higher monthly payments. Meanwhile, a longer loan tenure might slow down your savings or investments in the long run.
It’s important to assess your other financial obligations. If you have other regular payments that require your attention and resources, such as credit card bills or alimony, a longer loan tenure may be able to alleviate your immediate financial stress due to lower monthly loan payments.
If your loan has prepayment penalties
Some lenders charge you prepayment fees if you pay off your loan early. Make sure that you’re aware of any prepayment penalties. If there is a costly one, then you may want to more carefully choose a loan tenure in case you plan to repay your loan ahead of the maturity date.
Advantages and disadvantages of opting for a longer loan tenure
At the end of the day, each borrower has their own financial goals and circumstances, which leads to unique loan tenure optimization processes. Here are the main benefits and drawbacks to choosing a longer loan tenure.
Cheaper monthly installments: A longer tenure allows you to spread out the same loan amount you need to repay over an extended period of time. Not only does this give you more time to gather the money required to repay the loan, but it can also reduce the amount you need to pay each billing cycle.
Easier on your debt-to-income ratio: Your debt-to-income (DTI) ratio expresses what percentage of your monthly income goes toward repaying debt. By having a longer loan tenure, you may be able to reduce your DTI ratio. A low DTI ratio can then lead to a better credit score.
More breathing room: If you’ve just obtained a personal loan, it’s likely that you will be more financially strained for the time being. A longer tenure gives you more time to repay your loan through lower monthly installments. The reduced financial burden can go a long way.
- Higher total interest paid: Even if the interest rate is lower, a longer loan tenure can result in you paying the lender more total interest over time. This is because a longer loan tenure means that more interest will accrue. Since there is a higher total cost of borrowing, this drawback may deter you from choosing a long loan tenure.
- Longer time in debt: Naturally, a longer tenure means that you are committing yourself to be in debt for a long period. This might prove to be a stressor that obstructs your other financial goals, especially if you opt for a loan that takes many years to repay.
- Higher interest rate: If you pick a longer tenure, your lender might give you a higher interest rate. This is because the extended period of the loan brings higher risks to the lender. Borrowers might default on loans with long tenures, which means that the lender will lose a lot in interest.
- Impact on credit score: Although credit scores can be complicated and having debt may raise your score if you showcase good credit behavior, the potential negative impact of choosing a long tenure can be significant. If you continuously miss your monthly payments and have outstanding debt for months or even years, your credit score can be seriously damaged.
How to calculate the total interest paid over different loan tenures
The formula used for total interest paid depends on whether your loan comes with simple or compound interest. The basic formula for calculating your interest paid is:
Principal Loan Amount x Interest Rate x Loan Term = Total Interest Paid
Assuming that the principal loan amount and interest rate remain the same, the greater the loan term, the more total interest paid.
You can use an online loan interest calculator to easily find out your expected total interest paid.
The impact of loan tenure on the total cost of the loan
A longer loan tenure results in a higher total loan cost. You would pay your lender more total interest since your monthly interest can add up significantly over a long tenure.
The main benefit to a short loan tenure is that you can save more money overall due to less interest accruing over the life of your loan. You can also get rid of your debt burden as soon as possible, which many borrowers find to be an appealing option.
How to balance loan tenure with other financial goals
Balancing your loan tenure can enable you to maintain a healthy financial outlook. However, it can also be a tricky process. Here are some tips that can help you better balance your loan tenure:
Assess your monthly cash flow
To determine your cash flow, look at your monthly income and expected expenses. In addition, note down how much of your money needs to be allocated towards financial obligations (e.g. credit card bills) or your emergency fund. After you get a good idea of your typical cash flow, you can determine how much you can afford to use for loan repayment each month.
If you find that you have more than enough cash flow to comfortably make your monthly payments, you might want to consider a shorter loan tenure. Even though monthly payments will be more costly, shorter loan tenures usually allow borrowers to save more money in the long run because of less interest accrued.
Seek professional counsel if necessary
If you’re feeling overwhelmed by your personal loan terms and requirements, you may want to approach a financial advisor or planner. They can help you figure out what the optimal loan tenure is for your particular circumstances.
The role of credit score in loan tenure selection
Your credit score can affect what loan tenure the lender is willing to grant you, as well as what tenure may work best for your circumstances. If you have a good credit score, your prospective lenders will likely be more willing to compromise on your loan terms and conditions with you.
Meanwhile, if you have poor credit, you might not be allowed to take out your desired loan tenure because the lender may doubt your ability to repay the loan. This typically means you will be restricted to short loan tenures.
How to negotiate loan tenure with the lender
Like with the other terms of your loan, your lender might be willing to compromise on your loan tenure. Here are some key points to keep in mind so you can more effectively strategize for your loan negotiations.
- Research different lenders
Remember that in most cases, you are not locked into a single creditor. Before signing a loan agreement, make sure that you’ve considered all the lenders available to you. You should research the standard loan terms and conditions for those who have your credit score and desired loan type.
- Understand your position and what you’re seeking
When going into negotiations, it’s important to know your own financial situation and what the desired outcomes are. For example, if you have a high monthly income and prefer to pay off the loan as soon as possible, you may want to negotiate for a shorter loan tenure.
- Be polite and professional
When contacting your lender about your personal loan tenure selection, it’s advisable to express your needs and expectations clearly and politely. By keeping negotiations civil, you can raise your chances of receiving more favorable loan terms.
- Highlight your creditworthiness
Being creditworthy makes a big difference in whether a lender will be willing to change your loan terms for you. To highlight that you are a reliable borrower, you can provide relevant documents that demonstrate your creditworthiness as well as financial stability. You may also want to emphasize during negotiations that you have a good credit history if applicable.
Supporting documentation may include:
- Proof of income
- Proof of employment stability
- Credit reports showcasing your good credit behavior
- Know your stance but be adaptable
Like all types of negotiation, it can help to know how much flexibility you are willing to have. Listen to the alternatives that the lender suggests and consider whether those are beneficial changes to you.
- Review and clarify before agreeing to anything
Signing a loan agreement means committing yourself to a legally bound contract. It’s critical to check and clarify all terms and conditions before you sign any agreement.
The impact of prepayment on loan tenure and total interest paid
Prepayment refers to either paying your entire loan back early or a portion of it by making extra payment installments. Some loan agreements designate prepayment penalties, which may be either a flat fee or a percentage of your outstanding balance. These penalties are meant to help lenders recoup the money they would’ve otherwise made on your interest payments.
If you make a prepayment, you can reduce your loan tenure because you are reducing the amount you still need to repay.
The importance of reviewing loan tenure periodically
Better interest rates for loan refinancing
Average interest rates for personal loans change over time based on various economic factors. If you have a long loan tenure, it’s a good idea to keep an eye out for fluctuating interest rates.
If the average interest rate is a lot lower than your current interest rate, you might want to consider refinancing your loan. A loan refinance allows you to obtain a new loan with more favorable terms, such as a shorter tenure or lower interest rate.
Shifting priorities and goals
Periodically reviewing your loan tenure can help you decide whether your loan tenure still aligns with your financial and life goals.
For example, if you are planning on funding a child’s education, you might want to free up your finances so that you can allocate more of your budget toward the education fund. This might drive you to renegotiate the loan tenure to better fit your priorities. Other situations that may change your circumstances include marriage, unemployment, a new job, and emergencies.
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