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Long-Term or Short-Term Loan: Which One Should I Take?
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Long-Term or Short-Term Loan: Which One Should I Take?

If you’re considering taking out a loan, you may have noticed lenders offer loans with different borrowing periods. 

Some will let you borrow and repay a loan over shorter periods, or “terms,” while others will allow you to spread the borrowing out over several years.

So, for example, a loan of Ksh500,000 could have a term of 12 months, three years, or even ten years. The loan terms offered by the lender can vary based on factors like your credit rating, the type of loan, and your preference.

Your loan term will affect how much you can borrow, how much you will repay per month, and how much interest you will pay over the life of the loan. Before applying for a loan, it is vital to understand the difference between short- and long-term loans.  

Read Also: How to Get The Most Out of Your Loan

Understanding Loan Terms

A loan term is the period over which borrowed money will be repaid. They can vary in length, impacting how much you repay each month and the total amount you will repay, including interest.

Typically, the loan terms constitute a legally binding component of the credit agreement. In other words, once you enter the loan contract and receive the funds, you must make repayments according to the agreed schedule and loan term.  

Lowering or extending a loan term by making fewer or more repayments may result in fines.  

There are two main types of loans you can apply for short-term and long-term loans. 

Short-Term Loans

These are loans with a shorter repayment period, ranging from a handful of days or weeks to one year. 

Short-term financing can be used for personal or business purposes, including covering unexpected immediate expenses or managing cash flow. Common types of short-term loans include digital loans, advance salary or payday loans, and emergency sacco loans.

Short-term loans typically don't require a collateral or a guarantor. However, some lenders, such as microfinance institutes, will let you use your car logbook to secure short-term logbook loans. Other credit institutions, including commercial banks, offer secured and unsecured short-term loans. 

Short-term loan advantages

  1. Easy to apply and Quick access to cash - You can receive funds in minutes depending on the type of short-term loan you want. 
  2. There are plenty of options to choose from, as many lenders offer short-term loans compared to long-term loans.
  3. With a short-term loan, you will pay less interest in the long run. However, rates are typically higher.  
  4. Short-term loans may be available to people with low credit scores and no credit history. When used well, they can help you build your credit history and improve your credit scores. 

Short-term loan disadvantages

  1. Your monthly repayments will be higher as you are spreading the debt over short periods. This can create a burden and increase your chances of defaulting. 
  2. Short-term loans typically have a higher interest rate compared to long-term loans.
  3. Short-term loans are a bad fit for larger financial needs as the amount you can borrow is typically small and tied to a credit limit determined by the lender.

Read Also: How Do I Decide Whether to Take a Loan or Not?

Long-term Loans

Long-term loans are financial instruments with a repayment period extending beyond one year. This loan tenure can be somewhere between one and 30 years. These loans are often used for significant investments, such as purchasing a home, starting a business, buying a car, paying for higher education, or funding a large project.

You can borrow more money when you opt for long-term loans. However, lenders may ask for collateral, use what you are financing as collateral, or ask for a co-signer. 

Long-term loans typically have lower monthly repayments, which might make them look affordable. But they can be more expensive. This is because interest rates are presented annually, which means the longer you carry the loan, the more interest you’ll pay in the long run.

For example, let's look at a Ksh300,000 personal loan with a 17% APR interest:

Advantages of Long-Term Loans

  1. Long-term loans typically have lower monthly payments than short-term loans, making it easier for borrowers to manage their cash flow.
  2. Long-term loans provide access to significant amounts of capital, allowing borrowers to fund major projects or investments that may not be feasible with shorter-term financing.
  3. In some cases, the interest paid on long-term loans, such as mortgage interest, may be tax-deductible, providing potential tax benefits for the borrower.
  4. Flexibility to choose over how many years you want to repay the loan. You can negotiate for a period that aligns with your financial plan. 
  5. Lower interest rate compared to short-term loans.

Disadvantages of Long-Term Loans

  1. While monthly repayments and the APR may be lower, the total interest paid over the life of the loan can be substantially higher compared to shorter-term loans. This is due to the extended repayment period.
  2. Long-term loans may tempt borrowers to take on more debt than they can comfortably manage, potentially leading to financial strain and long-term loan burden. 
  3. Long-term loans expose borrowers to interest rate risk as they typically do not have fixed interest rates. If interest rates rise during the loan term, the cost of borrowing may increase, impacting the overall affordability of the loan.
  4. Long-term loans may have restrictions or penalties for early repayment, limiting the borrower's flexibility to pay off the debt ahead of schedule.
  5. Long-term loans require collateral; therefore, borrowers risk losing an asset if they default. Additionally, a long-term loan may result in negative equity where the borrower owes more than the asset is worth, especially if asset values decline.

Read Also: 8 Things You Must Not Overlook While Applying for Loan

Factors to Consider When Choosing Between Long-Term and Short-Term Financing 

Purpose of The Loan:

  • Short-Term Loan: Ideal for immediate needs or emergencies, such as unexpected medical expenses or urgent home repairs.
  • Long-Term Loan: More suitable for significant investments, such as starting a business, purchasing a home, or funding education.

Debt Tolerance:

  • Short-Term Loan: Usually results in a shorter debt period, reducing stress and the overall burden. However, the interest rates might be higher.
  • Long-Term Loan: Involves a more extended debt period, potentially causing more stress. However, the monthly payments may be more manageable.

Speed of Accessing Funds:

  • Short-Term Loan: Typically has a quicker application and approval process, making it suitable for urgent needs.
  • Long-Term Loan: Involves a more detailed application process, and approval may take longer, which may not be suitable for immediate needs.

Loan Amount Needed:

  • Short-Term Loan: Generally involves smaller amounts, suitable for covering immediate expenses.
  • Long-Term Loan: Appropriate for more significant financial needs, such as funding a business expansion or purchasing a high-value asset.

Collateral Requirements:

  • Short-Term Loan: May have less stringent collateral requirements, making it more accessible for individuals with limited assets.
  • Long-Term Loan: Often requires substantial collateral, such as property or valuable assets, which can be a barrier for some borrowers.

Market Conditions:

  • Short-Term Loan: Less susceptible to interest rate fluctuations in the market.
  • Long-Term Loan: Vulnerable to changes in interest rates during the extended repayment period.

Credit Rating:

  • Long-Term Loans: Generally requires a strong credit rating as lenders are exposed to risk over an extended period.
  • Short-Term Loans: These may be accessible with bad credit, but creditworthiness still plays a crucial role as it dictates how much you will qualify. 

Income Stability:

  • Short-Term Loan: Requires a stable income to make timely payments for a shorter duration.
  • Long-Term Loan: Demands consistent income over an extended period, ensuring the ability to meet long-term obligations.

Future Financial Plans:

  • Short-Term Loan: More suitable if you have plans that require financial flexibility soon.
  • Long-Term Loan: Appropriate if you have long-term financial goals and are willing to commit to a more extended repayment period or if the extended loan is part of your plan. 

Read Also: How to Figure Out if Something is Worth Taking a Loan For

WRAPPING UP

The decision between a long-term and a short-term loan depends on your financial needs, goals, and the specific circumstances of your situation. 

If you can quickly repay the loan or have urgent financial needs, a short-term option might be more appropriate. Short-term loans can be useful for financing specific projects with a quick turnaround, such as inventory restocking, seasonal business fluctuations, or capitalizing on a short-term business opportunity. Short-term loans may have higher interest rates, but if you can repay the loan quickly, the overall interest paid may be lower than a long-term loan. 

Long-term loans may be suitable for larger capital investments, such as buying real estate, equipment, or business expansion. Additionally, a long-term loan with a fixed interest rate may be a better option if you prefer stable and predictable monthly payments.  

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Farah Nurow is an experienced Content Writer who enjoys writing creative and educative articles meant to provoke readers' thoughts. He loves sunny weather and thick books. You can connect with him on LinkedIn.

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