What Is a Loan Term?
The term is easy and obvious to identify with some loans. 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.
Loans can last for any length of time that's agreed upon by the lender and the borrower.
- Alternate definition: Loan terms can also be factors like the interest rate and other requirements that the loan contract provides for
- Alternate name: Terms and conditions
How a Loan Term Works
Your lender typically sets a required monthly payment when you take out a loan, such as a 60-month auto loan. That payment is calculated so that you pay off the loan gradually over the loan’s term. Your last payment will exactly cover what you owe at the end of the fifth year. This process of paying down debt is called amortization.
A loan’s term affects your monthly payment and your total interest costs. A long-term loan means you'll pay less in principal each month because the total amount you borrowed is broken down over more months, so it can be tempting to choose one with the longest term available. But a longer term also results in more interest charges over the life of that loan.
You effectively pay more for whatever you’re buying when you pay more interest. The purchase price doesn’t change, but the amount you spend does.
Other Types of Loan Terms
Loan terms can also be the characteristics of your loan, which your loan agreement would describe. You and your lender agree to specific conditions—the "terms" of your loan—when you borrow money. The lender provides a sum of money, and you repay that sum according to an agreed-upon schedule. Each of you has rights and responsibilities per the loan agreement if something goes wrong.
Some of the most common terms include the interest rate, monthly payment requirements, associated penalties, or special repayment provisions.
Loan Terms vs. Loan Periods
Loan periods are also related to time, but they aren’t the same as your loan term. A period might be the shortest period between monthly payments or interest charge calculations, depending on the specifics of your loan. 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.
|Loan Term||Loan Period|
|The length of time it will take to pay off a loan||The shortest period between payments or interest calculations|
|The contractual obligations of a loan, such as interest rate and payment due dates||The period of time when a loan is available, such as a student loan for a given semester|
Effect of Loan Terms
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. Your loan might have a fixed interest rate that remains the same over the life of the loan, 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. There are several ways to calculate the required payment. Credit cards might calculate your payment as a small percentage of your outstanding balance.
Minimizing interest costs is often wise. You'll lose less money to interest charges if you can pay off your debt faster in a shorter loan term. Find out if there’s any penalty for paying off loans early or for making extra payments so you can pay it off before the set loan term ends. Paying more than the minimum is smart, especially when it comes to high-cost loans like credit cards.
You don’t pay down the balance gradually with some loans. These are called "balloon" loans. You only pay interest costs or a small portion of your loan balance during the loan’s term. You'll then have to make a large balloon payment or refinance the loan at some point.
- A loan term is the duration of the loan until it's paid off, such as 60 months for an auto loan or 30 years for a mortgage.
- You’ll pay more interest overall on a long-term loan, but your payments will likely be less because the principal balance you borrowed is spread out over more months.
- “Loan terms” can also refer to the specifics of a loan, such as the interest rate you’ll be paying and other requirements.