Category: Advice

Understanding Loan Duration

When looking to take out a loan or other form of credit, the borrower can often become overwhelmed by the sheer amount of options available. This isn’t just the number of lenders (from major banks to small online lenders), but also the variety of features (such as secured and unsecured, payday loans, mortgages, microloans, credit cards, and an endless list of other options). Before choosing a loan you also need to consider what is known as the loan term or duration, which is how long the loan will be outstanding before you have paid it all back. In general this falls under short, medium and long. Which you choose will depend on your personal situation. Each option will have an impact on the amount you can borrow and the interest rate, so you must take the time to consider it fully.

Short Term Loans

Short term loans are loans that are outstanding from between a couple of weeks to a couple of months. Common types of short term loans include

Payday Loans: A small loan with one repayment on or just after your next pay day (two weeks on average).

Pawn-Brokering: This is when you give a broker an item of value and get a percentage of its worth as a loan). As long as you repay the loan within the time-frame given, you will get the item back. If not they will sell it to cover the debt.

Informal loans from friends and family.

Due to the nature of a short term loan the amount you can borrow is usually small (typically from a few hundred to £1,000) – especially if you’re talking about no credit check loans. Anything more and you are unlikely to be able to pay it back in the timeframe given. Because of the small duration interest rates are also one of the highest in the industry, as the lender needs to make it worthwhile for their profit-margins.

Asset-Backed Loans: Short-term loans are often available at better amounts and interest rates if you off collateral. The concept is very similar to that of pawn-brokering, however these loans are usually offered by traditional lenders.

Short term loans are ideal for those that are temporarily in need of a small influx of cash, maybe to cover an unforeseen bill or expense, or to purchase a product upfront. As long as you can cover the debt with your next paycheque or couple of paycheques, you should be ok. While comparatively you will be paying more in interest, this won’t have a real world impact unless you end up taking out lots of small term loans in a row. If this is likely to happen you should consider taking out a medium term loan.

Medium Term Loans

Medium term loans are loans that have durations of between 1 and 7 years, and are typically issued from mainstream banks and lenders. They will commonly fall under the term “personal loans” but can have several different options – including secured and unsecured (collateral or no collateral). The loan is repaid with interest in instalments (usually of equal amounts on a monthly basis).

On average in the UK medium term unsecured loans come in values between £1000 and £25,000. The amount you are offered depends on how much you request but more importantly, your income status and credit history. You are more likely to be approved for larger amount if the duration is longer, because this makes the monthly repayments smaller and you will be less likely to struggle. The longer the duration the smaller the interest rate. Likewise, shorter durations command bigger interest rates. It is important to understand that even with a longer duration and shorter interest rate, you will still typically pay more in the end.

Long Term Loans

Long terms loans of over 7 years are almost exclusively reserved for mortgages, which are loans to buy homes and properties. These come in amounts in the tens of thousands to hundreds of thousands, and can be repaid over many years. Commonly this is 25 years but some lenders have been known to offer mortgages for as long as 50 years.

Mortgages are one of the most stringent types of loan in terms of credit and background checks. The money legally has to be used to fund the purchase of a property; you must provide lots of proof of income, and they may ask you all sorts of questions. These can include whether you have children or plan to in the future, what you typically spend your money on each month, whether you have student loans and other debt, and more.

Over time as you have paid off a portion of your mortgage, you will gain what is known as equity. This is basically the amount of the property that you own. You can “remortgage” or take out a home equity loan on this percentage.