When taking out a personal loan, one of the key decisions you’ll have to make is what term to select. A loan’s repayment term (i.e., how long you have to pay it off) can significantly impact your monthly payments, the total amount of interest you pay, and how quickly you become debt-free. Understanding how different term lengths affect loan repayment can help you make an informed choice that aligns with your budget and financial goals.
Below, we walk you through how personal loan term lengths work, and the pluses and minuses of going with a shorter- versus a longer-term loan.
What Does Personal Loan Term Length Mean?
Put simply, the term length of a personal loan is how long you have to pay it off. More specifically, it’s a period of time that starts when you receive the loan funds and ends when your final payment is due.
Personal loan terms vary depending on the lender and the amount of the loan, but typically range from two to seven years. Lenders will often give you a choice of loan terms. The length you choose will determine your monthly payment amount and the total amount of interest you’ll pay over the life of the loan. It can also impact the interest rate you’ll pay.
How Do Personal Loan Terms Work?
When you take out a personal loan, you’ll receive the full amount of the loan (called the principal) up front. Typically, you need to start paying back the principal, plus interest, in monthly installments within 30 days. These monthly payments will continue throughout the term of the loan.
Generally, the larger the loan, the longer the term will be. For example, a $500 personal loan will often have a term of one year or less, while a $15,000 loan might have a three- to four-year term. Loans of $30,000 or more can have terms ranging from five to seven years.
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Factors to Consider When Choosing a Personal Loan
There are a number of things to consider when taking out a personal loan. These include:
• Loan amount: It’s important to take out a loan that’s enough to cover your needs but not more than you’ll need, since you’ll be paying interest on these funds. While you can find personal loans as small as $500, many lenders have loan minimums of $1,000 to $2,000.
• Interest rate: Rates for personal loans can range anywhere from 5.99% to over 29.99%. The rate you’ll pay will depend on the lender, the loan amount, the loan’s term, and your credit score. Generally, you’ll get a lender’s lowest rate if you have a good or excellent credit score and select the shortest available term.
• Repayment term: The less time you’re in debt, the less time interest has to accrue. Thus, going with a shorter loan term can lower the overall cost of a personal loan. However, it means your monthly payments will be higher. Repayment terms can also impact personal loan rates, with longer terms typically linked to higher rates, since they pose more risk to the lender.
• Collateral: Personal loans are typically unsecured, which means you don’t have to pledge a valuable asset (collateral) to back up the loan. There are some secured personal loans, however. Since collateral lowers a lender’s risk, secured loans tend to have lower interest rates than unsecured loans. However, should you fall behind on payments, the lender can seize your collateral to recoup their losses.
• Origination fee: Some lenders charge origination fees to cover the processing costs of the loan. These fees can range from 1.00% and 8.00% of the total loan amount. In some cases, you need to pay this fee in cash at closing; in others, the lender adds it to the amount you’re financing or subtracts it from your loan before it’s dispersed. Some lenders, however, don’t charge origination fees for personal loans.
• Prepayment penalty. If you pay off your personal loan early, a lender might charge you a prepayment penalty to make up for the loss in interest. But not all lenders charge a prepayment penalty.
Pros of Short Term Loan Length
Here’s a look at some of the advantages of taking out a personal loan with a shorter repayment term.
Faster Debt Repayment
One of the main advantages of a short-term loan is that you can become debt-free more quickly. By committing to higher monthly payments, you reduce the loan balance faster, which can free up your income for other uses sooner.
Lower Total Interest Costs
Because you are paying off the loan more quickly, there is less time for interest to accrue. As a result, shorter-term loans typically result in lower total interest costs, saving you money in the long run.
Potential for Lower Interest Rates
Since shorter terms reduce risk to the lender, you may be able to get a lower interest rate by choosing a shorter loan term. This can further decrease the overall cost of the loan.
Cons of Short Term Loan Length
Short-term personal loans also have some downsides, Here are some to keep in mind.
Larger Monthly Payments
One of the main drawbacks of a short-term loan is that you’ll have higher monthly payments. This might be challenging if your budget is already tight. It also means you’ll have less money to save and invest.
Less Financial Flexibility
With higher monthly payments, there is less room in your budget for unexpected expenses. This can be problematic if you encounter financial difficulties or need to redirect funds for emergencies.
Smaller Loan Amounts
Short-term personal loans tend to be for smaller amounts and may not be sufficient to cover your expense.
Recommended: How Much of a Personal Loan Can I Get?
Pros of Long Term Loan Length
Here’s a look at some of the advantages of choosing a personal loan with a longer term.
Smaller Monthly Payments
A longer term spreads the repayment over a more extended period, resulting in lower monthly payments. This can make the loan more manageable, especially if you have a tight budget or your income fluctuates.
Frees Up Funds
Lower monthly payments give you more flexibility in your budget, freeing up funds for other goals, such as saving, investing, or covering other expenses. This can be beneficial if you anticipate future financial needs or want to maintain a comfortable lifestyle while repaying the loan.
Larger Loan Amounts
Longer-term personal loans typically give you access to larger loan amounts. This can work well if you have a big expense, such as consolidating credit card debt, a wedding, or a home renovation.
Cons of Long Term Loan Length
There are also some disadvantages to going with a longer loan term. Here are some to keep in mind.
Higher Costs
While longer terms generally make monthly payments smaller, extending the time you take to repay a loan typically leads to higher overall interest costs.
Extended Debt Duration
A longer loan term means you’ll be in debt for many years. This prolonged commitment could potentially become a drag on your budget or impact your financial planning, such as saving for retirement or other long-term goals.
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Potential for Higher Interest Rates
Longer terms lead to increased risk for lenders. As a result, they may charge higher interest rates, which can further increase costs.
Choosing the Best Loan Term Length
When deciding on the best term length for a personal loan, you’ll want to factor in your monthly budget, financial goals, and the total cost of the loan. Here are some tips to help you decide on the best term length for a personal loan.
• Assess your financial situation: You might start by taking a look at your current monthly income, expenses, and savings targets. From there, you can determine how much you can afford to pay each month without compromising your lifestyle or future goals.
• Compare interest rates: It’s a good idea to shop around for lenders offering the best interest rates for different term lengths. A slightly higher interest rate might be acceptable if it results in more manageable monthly payments.
• Calculate total costs: There are online calculators that can help you compare the total interest paid for different term lengths. Understanding the long-term cost implications can help you make an informed decision.
• Consider flexibility: Check if the loan allows for early repayment without penalties. This flexibility can be handy if your financial situation improves and you want to pay off the loan faster.
The Takeaway
The right personal loan term length for you will depend on several factors, including your budget and future goals. Generally, going with a shorter term makes sense if you can afford a higher payment, want to save money on interest, and prefer to get out of debt quickly. However, you might be better off with a longer term if you need a more affordable monthly payment and want more flexibility, since you can typically pay your loan off ahead of schedule (just watch for any prepayment fees).
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
FAQ
Can personal loans be 10 years?
Yes, personal loans can have terms up to 10 years, although they are less common. Long-term personal loans typically range from two to seven years, but some lenders offer 10-year terms for specific purposes or higher loan amounts.
While a 10-year term can provide lower monthly payments, it often results in higher total interest paid over the life of the loan. Before you sign a long-term loan agreement, you’ll want to carefully consider the total cost and your ability to commit to such an extended repayment period.
Is it OK to pay off a personal loan early?
Yes, it’s generally okay to pay off a personal loan early, and can even be beneficial. Paying off your loan ahead of schedule can save you money on interest and free up money for other goals.
However, it’s important to check your loan agreement for any prepayment penalties. Some lenders charge fees for early repayment to compensate for the lost interest. If there are no penalties or the savings outweigh the fees, early repayment can be a smart financial move.
Do personal loans hurt your credit?
Personal loans can have both positive and negative impacts on your credit. Initially, applying for a loan results in a hard inquiry, which can temporarily lower your credit score. Taking on new debt may also affect your credit utilization ratio.
However, consistently making on-time payments can benefit your credit over time by demonstrating responsible credit behavior. Taking out a personal loan may also diversify your credit mix, which could also positively impact your credit. The key is to manage the loan responsibly and avoid missing payments to maintain or improve your credit profile.
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