How The Term of a Loan Affects The Interest You Pay
When you take out a loan there are a few factors the lender uses to make a decision as to if they will grant the loan or not. Two of the largest factors are affordability, and also your credit score.
Affordability is usually the main factor looked at first when underwriting a loan, with credit history and credit score right next to it.
Once these two factors are reviewed and if you meet the tests of affordability, and your credit score is within the guidelines used by that lender for the type of loan you are requesting, usually everything else falls into place.
Then there are a few things you need to be aware of and are used in granting a loan:
* The loan amount
* The interest rate or APR/annual percentage rate
* The term of the loan, how long are you paying the loan back, the number of monthly payments
These factors will determine how much you repay in total for the loan.
Common sense states that a higher interest rate means you will pay back more in total, and a lower interest rate means you will be repaying back less.
And interest rates you may receive on a loan can be based on credit scores. Those with high or good credit scores can receive lower interest rates.
A borrower with a low credit score or bad credit, may get approved for a loan, but at a higher rate of interest.
Naturally higher interest rates can cause the monthly payments to be higher as well, so one way to reduce the monthly payments on a loan is to extend the term.
Loan Terms – Payments – Interest Paid
The longer the term is for a loan, can reduce the monthly payments.
A loan of £3000, at an interest rate of 3.5% for 12 months, the monthly payments will be £254.69, and you will be paying £56.28 in interest.
The same loan amount and interest rate for a term of 24 months, causes the monthly payments to be £129.54 and you will be paying £108.84 in interest.
Of course try to find a loan at 3.5%, the rates on personal loans are more like 9% or higher.
The same loan amount, £3000 at 9.9% for 24 months makes the monthly payments £137.71, and you are paying £305.09 in interest.
A longer term may help afford the monthly payments, but you also pay more in interest. Which is OK, as long as you are aware of this.
When you look at mortgage loans and terms, these numbers are much larger, due to the larger loan amounts, but also the terms now being offered for mortgages.
Property prices are high, so unless you have a large deposit, or buy a property under a low or no deposit scheme, your mortgage balance is going to be high.
Which means a high mortgage payment each month.
So lenders now are offering longer terms for mortgages. In the past 20 or 25 years seemed to be the usual term for a mortgage, however, today more and more lenders are offering 30 year and even 35 year mortgages.
In the United States, a 30 year mortgage was the standard for many years, but in recent times mortgage lenders there have been offering a 40 year mortgage.
While this is good to aid in making the large loans more affordable, and allows payments to be reduced, the amount of interest being repaid is in the tens of thousands of pounds more than if you had a shorter term loan.
So while the term of a loan does affect the amount of interest you pay, in the example of such a large loan like a mortgage, which can be for hundreds of thousands of pounds, when you extend the term longer the interest paid can be much higher.