Loan Term: Time Periods and Specific Features
Explanation of Loan Terms
A loan term can refer to several things. In most cases, the term is how long the loan will last if you make the required minimum payments each month. Loan terms can also refer to features of the loan that you agreed to when you signed the contract. These features are sometimes called the terms and conditions.
Time as Loan Term
The first example is about time. How long will the loan last until it is completely paid off with regular payments? The time it takes to eliminate debt is a loan’s term. Loans may be short-term or long-term notes.
In some cases, the term is easy to identify. For example, a 30-year fixed-rate mortgage has a term of 30 years. Auto loans often have five or six-year terms, although other options are available. Auto loans are often quoted in months, such as 60-month loans. However, loans can last for any length of time agreed to by the lender and borrower.
During a loan’s term, the loan must be paid off or refinanced.
When you get a loan (such as a five-year auto loan), your lender typically sets a required monthly payment. That payment is calculated so that you pay off the loan gradually over the loan’s term. At the end of the fifth year, your last payment will exactly cover what you owe. The process of paying down debt this way is called amortization.
Why It Matters
A loan’s term affects your monthly payment and your total interest costs (among other things). A longer-term means you pay less each month, so it’s tempting to choose loans with the longest term available. For example, you might think a 72-month loan is more attractive than a 60-month loan because it’s easier on your cash flow. But a longer-term also result in higher interest charges over the life of that loan.
When you pay more interest, you effectively pay more for whatever you’re buying. The purchase price doesn’t change, but the amount you spend does.
Loan periods are also related to time, but they aren’t the same as your term. Depending on the specifics of your loan, a period might be the shortest period between monthly payments or interest charge calculations. In many cases, that’s one month or one day. For example, you might have a loan with an annual rate of 12%, but the periodic (or monthly) rate is 1%.
A term loan period can also refer to times at which your loans are available. For student loans, a loan period might be the Fall or Spring semester.
Terms and Conditions of a Loan
Loan terms can also be the characteristics of your loan, which your loan agreement describes. When you borrow money, you and your lender agree to specific conditions—the "terms" of your loan. The lender provides a sum of money, and you repay according to an agreed-upon schedule. If something goes wrong, each of you has rights and responsibilities as per the loan agreement.
Some of the most common terms include the interest rate, monthly payment requirements, associated penalties, or special repayment provisions.
The interest rate describes how much interest lenders charge on your loan balance every period. The higher the rate, the more expensive your loan is. It’s crucial to understand if your loan has a fixed interest rate or a variable rate that can change in the future.
Lenders usually quote rates as an annual percentage rate (APR), which can account for additional costs besides interest costs.
Your monthly payment is often calculated based on the length of your loan and your interest rate. However, there are several ways to calculate the required payment. For example, credit cards may calculate your payment as a small percentage of your outstanding balance. Make sure you know how much you need to pay each month—and if that amount can change. You need to verify that the current and future payments fit within your budget.
Minimizing interest costs is often wise. If you can pay off your debt faster than is required, you lose less to interest charges. Find out if there’s any penalty for paying off loans early or making extra payments. Especially when it comes to high-cost loans like credit cards, paying more than the minimum is smart.
With some loans, you don’t pay down the balance gradually. Instead, you only pay interest costs or pay off a small portion of your loan balance during the loan’s term. In those cases, you often need to make a large balloon payment (or refinance the loan with another large loan) at some point. Prepare for a balloon payment by arranging financing (or earmarking liquid assets) several months or weeks before the payment is due.
Consumer Financial Protection Bureau. "What Is Amortization and How Could It Affect My Auto Loan?" Accessed Nov. 18, 2019.
Consumer Financial Protection Bureau. "Understand Loan Options," Accessed Nov. 18, 2019.
USA.gov. "Credit Cards," Accessed Nov. 16, 2019.
Consumer Financial Protection Bureau. "What Is a Prepayment Penalty?" Accessed Nov. 18, 2019.
Consumer Financial Protection Bureau. "What Is a Balloon Payment? When Is One Allowed?" Accessed Nov. 18, 2019.