Why You Should Keep Your Short Term Loan, there are many avenues you can explore. With so many options available—Kickstarter campaigns, business credit cards.
Traditional loan products, and more—it can be tricky to know which type is best for you.
What’s a term loan?
Before we dive into the differences between a short term loan and long term loans, let’s go over what a short term loan is more generally.
A term loan is when a lender approves you for a lump sum of cash that you pay back, plus interest and other fees, over time.
This is a traditional type of financing and probably what you’d imagine when you think of a loan.
The repayment term, or the amount of time you have to pay back the loan, is one of the major factors that distinguish a short- vs. long-term loan.
What is a short-term loan?
Short term loan operates much like the traditional term loan described earlier. You get a lump sum of cash that you pay off over time, plus interest and other fees.
However, the repayment term for this type of financing is characteristically short.
Typically, with a short term loan, you pay back the loan, plus interest, over three to 18 months with daily or weekly payments.
This differs from short term loan where you generally pay the loan back over a number of years with monthly payments.
Due to the shorter repayment period, short-term loans also come with higher interest rates, starting at around 10%. short term loan.
The amounts are typically smaller than those of long-term loans but can be as high as $250,000; short term loan is commonly secured online through alternative lenders.
Why consider a short-term loan?
A short term loan is ideal for college students dealing with the unexpected. Whether that’s a cash flow issue before your busy season, a surprise project that calls for additional supplies or equipment, or an uptick in demand for a product.
Short term loan can cover it all. Unlike some other loan products, there usually aren’t restrictions on how you can use the funds.
Because the application process typically takes place all online, approval can happen quickly, in as little as one day.
The shorter repayment term also means lenders are more willing to take a risk on a borrower who has weak credit, so even if your score is less-than-stellar you may still be eligible for this type of loan.
Terms for vehicle loans can vary widely based on the amount of down payment money you supply and the amount of monthly car payment you can afford.
Three or four years is a common loan term, but some loans can be stretched out to seven years or more.
A long-term loan can significantly reduce your monthly payments
It is usually not the best choice. Here are the reasons why:
- Higher Interest Costs – The tradeoff for your reduced monthly payment is a significantly higher amount of interest paid over the life of the loan. We illustrate this point by comparing a 2013 Honda Accord with five-year and seven-year terms using the available interest rates and price data.
- Their total to be financed was $30,266.A five-year loan carried a 2.69% rate and resulted in monthly payments of $540 and $2,115 in finance charges for a total of $32,381 paid.
- Meanwhile, a seven-year loan carried a 4.9% interest rate and resulted in monthly payments of $426 and $5,548 in finance charges for a total of $35,814 paid.
- You would be paying more than double the finance charges just for the ability to pay less each month – and that is comparing seven and five-year loans. Three-year loans provide an even larger contrast.
Short term loan
- Resale Value – Do you plan to keep the car for a long time? Depreciation is rapid for cars, and the resale value drops disproportionately in the first few years after purchase.
- If you plan to trade the car in relatively early and you have a long-term loan, you could find yourself in a situation where you still owe more on the car than its trade-in value. If you plan to keep the car for a long time, this is less of a concern. However, an accident in the early years can total your car and throw you into this situation involuntarily.
- The temptation to Overspend – The majority of people stretch out car payments because they cannot afford the monthly payment for a shorter term. However, you should also consider whether buying a less expensive car or a used car instead of a new car, would be a better choice.
- If you aren’t looking at the overall financial picture, a longer-term loan can lead you toward thinking you can afford a more expensive car that you may want but do not necessarily need.
- This might fulfill the goals of the car salesman — such as paying for his next car with the commissions he earns from your sale — while not being in your best interest.
- Clearly, you need to consider not only what monthly payment you can afford, but also project how long you can afford monthly car payments. There will be other expenses in the future to consider.
- Delaying Changes – If you are an average driver, you may get tired of your vehicle before the loan term is up – the average age of a trade-in for 2013 was 6.5 years. You may well love your car for many, many years, but you will be more hesitant to trade and have fewer options if you still owe money on your car.
The Pros of a 36-Month Car Loan
Lower Interest: Typically, the shorter the car loan, the better the interest rate the lender will offer. Shorter loans tend to have a lower risk of default by the borrower.
The lender rewards short term loan borrowers by reducing the interest rate. Essentially, you will pay less overall for your vehicle versus signing for an extended car loan.
Pay Off Your Car Loan Fast: A common car loan length is 60 months or 5 years long. Choosing a short-term car loan locks you into a larger payment versus a 60-month car loan, no going back and paying less.
The good news is you are on a path to getting out of debt in a reasonable amount of time. The faster you pay off debt, the faster you can move on to the next latest and greatest thing.
The best part about a short-term loan is that it is short term.
You Never Owe More Than the Car Is Worth: This one you hear all the time but most people do not think seriously about the consequences of owing more than a vehicle is worth.
If you are living paycheck to paycheck, owing more than the vehicle is worth is a very bad idea. Coming up with a large lump sum may be nearly impossible leaving you without a vehicle.
A total loss accident can leave you paying lots of money towards a vehicle you can no longer drive. Gap insurance can help, but it doesn’t always cover everything.
Did you finance a warranty or rollover a prior car loan? Gap insurance will not cover extras rolled into a car loan.
Vehicles depreciate and fast. Even a five-year car loan can put you behind when compared to your vehicle’s value.
A 36-month car loan will most likely keep you from being underwater on your auto loan. If you go into a short-term loan with zero money down, it is possible to owe more than the value of the vehicle, but it should not last very long.
You will be paying down the debt at a faster rate than what the vehicle is depreciating. Always keep an eye on the value versus what you owe. Vehicle depreciation is tricky.
Start Saving for Something Else
An awesome perk of a short-term loan is freeing up your money. Do with it what you like, but most personal finance advisers would recommend to save it.
Save it for your next vehicle purchase to reduce or wipe out a future auto loan. Put it in an emergency fund. Save for your kids’ college. Save it to your retirement account.
No matter what you do with the extra cash, it is money you would not have access to if you had taken out an extended car loan.
Car Insurance Choices
Wrapping up a car loan early leaves you with more options on your car insurance. We’re not saying to run out and drop physical damage coverage, but it is nice knowing you have the option.
Example: A major medical expense arises, and you are struggling to make ends meet. Because you paid off your car loan off fast with a short-term car loan, you can remove comprehensive and collision coverage especially if you are a military veteran.
It is just an example of an extreme situation. Hopefully, if the vehicle still holds a lot of value, you would take proper precautions and minimize the driving of the vehicle while coverage was lowered.
Physical damage could be added back on at the time you could afford it. The point here is that if you still had a loan on the vehicle, you would not be able to drop physical damage coverage because the lender requires it to be on the policy.
If the lender gets notified of the lowered coverage, they will most likely take out a third party car insurance policy which is very expensive and forward the bill to you.
The Cons of a 36-Month Car Loan
It Ties Your Money Up: Committing to a high monthly car payment is a big decision. Most importantly, the money will not be available for emergency expenses.
It is very important to figure out your budget before agreeing to the car loan terms. Make sure the likelihood of being tight on funds is very low throughout the entire course of your loan.
It makes no sense to agree to speed up the repayment process just to default and have the vehicle repossessed.
Other Car Loan Term Considerations
Explore all of your options. Use a car loan calculator to help you go through all the numbers. First, find out what the interest rate options are per length of the car loan.
Then input the length of the car loan with the coordinating interest rate into the car loan calculator. Write down all the loan payment amounts.
48-Month Car Loan: Sometimes the lender charges the same interest rate for both the 36-month car loan and the 48-month car loan.
Consider taking the lower monthly payment with the longer loan, then pay more than the minimum. The big difference here is if you run into a financial jam, you can very easily start paying the minimum due to free up money for the emergency.
60-Month Car Loan: Even if a 60-month car loan comes with a little higher interest rate, it is still possible to pay the loan off early. (Assuming there are no fees in the small print for paying off the loan early.) Again, just pay more than the minimum due.
At the end of the loan, the final difference in interest may not be all that much. Plus, you have the freedom to lower your payment to the minimum due anytime you see fit.
Longer than 60-Month Car Loan: Going longer than 60 months on a car loan is not recommended.
It is usually a sign you cannot afford the vehicle. Refer back to the part about owing more than the vehicle is worth.
The higher interest rates combined with the length of the loan nearly makes staying ahead of depreciation impossible.
Paying extra on car loans does not work for everyone. For some, the temptation of accessible cash is just too much.
Locking yourself into a short-term loan and committing to improving your financial future only works if you can stick with it.
Refinancing is a possibility, but it can also be a hassle. Your best bet is to pick the proper loan the first time around.
It is easy to see there are many more pros to a short-term loan than cons. Please keep in mind there is no perfect car loan for everyone.
Everyone has a different story and different circumstances. The most common auto loan is now averaging more than 60 months.
Cars are becoming more and more expensive making a short-term loan more and more difficult to afford. Budgeting properly can be a game changer for your entire future.
Choosing the right car loan length can help get you to financial freedom. Before you sign up for that long-term car loan, run some numbers and think about these points.
You may decide that a shorter-loan term is in your best interest after all.