Personal loans are like a lending Swiss Army knife: Their versatility means that, no matter what your financial goal is, you can usually find one that fits your needs. But with so many personal loan term lengths available, how do you choose the best one?
Your ideal loan term length will be the one that offers a payment that fits your monthly budget and a total borrowing cost that won’t keep you up at night. First, you’ll need to understand your term options. Then, you can use the three criteria below to evaluate your options and choose the term that’s right for you.
[Read: Best Personal Loans.]
What Are Common Personal Loan Term Lengths?
Personal loans come in a variety of term lengths, but you will typically have between one and five years to repay your loan. While there’s no simple definition for what qualifies as a short- or long-term loan, the term length can affect your loan’s affordability.
Short-Term Personal Loans
While quickly knocking out debt can be challenging, you can make it happen with a short-term personal loan. When you opt for personal loans with shorter terms, the financial benefits can include:
— Lower total costs. Interest rates for short-term loans can be lower than rates on credit cards and longer-term loans. This can translate to significant savings.
— Faster payoffs. Short repayment schedules can get you out of debt and back on track fast.
Long-Term Personal Loans
While rates on long-term personal loans are still usually lower than rates on credit cards, they can be higher than their short-term counterparts. Lenders may consider borrowers higher risk when they take more time to repay, and offset that risk with a higher rate.
With longer terms come lower monthly payments, but you may pay more in total loan costs. Still, long-term personal loans offer these advantages over shorter-term loans:
— Lower monthly payments. With longer to repay your loan, monthly payments can be considerably less than those with shorter terms.
— Can enable you to borrow a larger amount. Lower monthly payments can make larger loans easier to manage.
[Read: Best Low-Interest Personal Loans]
3 Tips for Evaluating Personal Loan Term Lengths
When you apply for a personal loan — whether through a bank, credit union, online lender or peer-to-peer lender — you’ll often find an abundance of choice. You can prequalify with multiple lenders and compare offers.
These tips can help you crunch the numbers and find the term length that makes the most sense.
1. Consider Your Finances, Today and Tomorrow
“When I think about term length, I think about the current interest rate environment, but also about the client’s personal cash flow,” says Paul Ayotte, founding partner and client advisor with Fidelis Capital. You can subtract your expenses over a set period, such as a month, from the funds you took in over that period to see your cash flow.
Ayotte considers his clients’ current and future cash flows. Using current and projected financial data can help you choose a term length that makes sense for the life of your loan, not just today, Ayotte says.
You’ll need to look to the future to understand the total cost of the loan. For example, say you take out a 60-month personal loan with a low monthly payment. While you get the low payment today, you might pay more in total borrowing costs due to the amount of interest you’ll pay over five years.
“A personal loan needs to benefit you not just in the short term but also long term,” says Ryne Vickery, a certified financial planner at Buckingham Strategic Wealth.
Remember that personal loans have dials you can turn in the form of your term length and monthly payment. Use them to customize a loan that’s right for you today and tomorrow.
2. Determine How Big a Monthly Payment You Can Afford
It’s easy to be tempted by a lower monthly payment for a longer personal loan term. However, the most important thing about a monthly payment is that it makes sense for both your financial and personal situation.
For instance, say you are considering three choices for a $10,000 debt consolidation loan:
— 60 months at 14% for $233/month
— 48 months at 13% for $268/month
— 36 months at 12% for $332/month
While that $233 monthly payment might fit most comfortably in your budget, you may not want to carry this debt for five years. In this case, you could consider trimming a few expenses and taking the three-year term for $100 more per month.
But in some situations, the best personal loan term length may be the one that makes your loan the most affordable each month. For instance, say you borrow $30,000 to pay for family-building expenses like adoption or fertility treatments. You might prefer a lower payment and longer term to get the funds you need today, but still leave wiggle room in your budget for other expenses along the way.
3. Shop Around for the Best Rate
Personal loans typically have lower interest rates than credit cards. For instance, the average annual percentage rate for a 24-month personal loan was 11.23% in November 2022, compared to 19.07% for credit cards, according to the Federal Reserve.
To maximize your savings, it pays to shop around for the lowest interest costs for any personal loan term length.
Many lenders allow borrowers to see an estimated interest rate with a soft credit check. Since soft checks don’t impact your credit, you can afford to prequalify and compare APRs from multiple lenders.
[Read: Best Debt Consolidation Loans.]
Which Personal Loan Term Length is Right for You?
So, should you choose a short-term or long-term personal loan? Here are some scenarios where each might make sense. You can also use a personal loan calculator to see how different terms affect your payments.
A short-term personal loan might be better if:
— You want a quick payoff. If having debt isn’t your thing, you might appreciate a shorter repayment timeline.
— You can handle a higher monthly payment. As a result, you could repay your loan balance faster and save on total borrowing costs.
A long-term personal loan might be better if:
— You need a lower monthly payment. Longer terms can make loan payments more affordable on a month-to-month basis.
— You want payment flexibility. With a lower monthly payment, you still have the option to pay more when you can to help speed up the payoff. If you plan to pay off your personal loan before the term ends, make sure you know whether your lender charges a prepayment penalty.
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What Personal Loan Term Length Should You Choose? originally appeared on usnews.com
