Loans are essentially financial tools that can bridge the gap between your current financial capability and financial goals Short Term Loan Vs Long Term Loan. All financial goals are not the same and can be differentiated based on the funds required. Time horizon, urgency, level of importance, etc. Similarly, loans needed to finance goals must have different durations and interest rates to better match specific outcomes. In general, loans are of mainly two groups. Short-term or short-term loans and long-term loans. These loans vary according to the registration process, repayment period, interest rates, etc
Let’s dive deep into understanding how these two types of loans work –
Short Term Loan Vs Long Term Loan
Short term loan
Loans that are used to meet a temporary financial need or even a small business expense are called short-term loans. These loans are so-called based on their quick turnover or repayment. In most cases, such loans need to be repaid within a year, give or take a few months. Short-term personal loans, business cash, payday loans, invoice financing, etc. are some examples of short-term loans.
Short-term loans are generally suitable for temporary or minor financial disagreements. For example, your laptop may need to be replaced, but it’s the end of the month and you’re running out of cash. For such an expense, you can choose a short-term personal loan and repay it within one year.
Advantages of short-term loans
The advantages of short-term loans are as follows:
Quick fix your finances
Regardless of your financial preparedness, life can throw you a curveball with unexpected financial expenses that you may not be able to pay. In such moments, a short-term loan can save you. These short-term loans can give you a financial cushion when you need them most.
Upgrade your credit score
A short-term loan can help you build a good credit history, which can come in handy if you use a long-term personal loan in the future. So, if you want to borrow for larger expenses, such as buying your own home, you can start by taking out and managing short-term loans.
Shorter approval process
Short-term loans generally have a quick approval process. The requirements for such loans are generally uncomplicated, as the amounts are generally small and the duration is short. And due to the minimum required documentation, loans can be processed quickly.
As we go through life, there are many milestones we would like to reach. Goals like buying your own house, funding your child’s education abroad, etc. are things that require significant financial resources. More often than not, it is very difficult to support these wishes by simply dipping into savings. For such goals, you need significant credit support. This is where taking out a long-term loan can be useful.
A long-term loan is a debt that is offered for a long period of time. The repayment schedule of these loans usually exceeds 24 months and can be up to 30 years. These debts are secured, which means that the loan is sanctioned by the security. The interest rates are generally reasonable. Home loans, education loans, car loans, etc. are some examples of long-term loans.
Advantages of long-term loans
The advantages of long-term loans are as follows:
Borrow a large amount
First of all, long-term loans allow you to borrow a significant amount. There’s no need to disrupt your investments or empty your savings account to meet essential goals. Long-term loans help you finance expensive but necessary purchases like home ownership without affecting your cash flow. Additionally, a major purchase comes with its own set of associated costs that we don’t consider. For example, owning a new home will also mean paying for a myriad of expenses that we overlook, such as utility bills, interiors, property taxes, maintenance bills, etc. A loan for a longer period thus helps to manage all these recurring expenses. Read more:
Long-term loans can be repaid over a longer period of time, which is largely reflected in lower monthly payments. These costs then become manageable, allowing you to set your monthly budgets sensibly. Long-term loans are thus an attractive option for people who want to limit their monthly expenses and allocate a larger part of their income to savings and investments.
As explained earlier, long-term loans generally involve sanctioning a large amount of principal which is there in collateral. They also have a longer repayment period. Due to these features, long-term loans usually offer lower and more competitive interest rates.
Short-term loan vs long term loan
Here is a comparison between short-term and long-term loans:
Duration and Interest
The duration and price of loans are negatively correlated – meaning they move in opposite directions. Therefore, if the tenure is short, the interest rates offered are comparatively higher and vice versa. Additionally, short-term loans usually charge a higher interest rate compared to long-term loans.
Short Term Loan Vs Long Term Loan: The need for collateral
Long-term loans involve higher amounts paid over a longer period. That is why in this case the lenders require security in the form of collateral in exchange for the loan. In the event that the borrower defaults on the loan, the amount owed can be recovered by liquidating the collateral. In contrast, short-term loans are largely unsafe because they involve smaller amounts.
Short-term loans are less risky for lenders. Therefore, they only have minimal documents in the form of proof of identity and income. In contrast, lenders face a higher risk of default in the case of long-term loans. Lenders must therefore be convinced of the borrower’s ability to repay the loan. This involves submitting many documents to the lender for verification and review. While the process varies across banks. And financial institutions, to a large extent the borrower needs to supply IT returns, and salary slips. Bank statements and property documents, among others. These documents serve as proof of the borrower’s creditworthiness and eligibility for access to long-term loans. Source: Definitive Guide