4-minute read UPDATED: May 20, 2023
When you take out a loan, whether it’s to fund a car or home purchase, you and your lender agree to a set of conditions outlining what’s expected of you throughout the length of the loan. But what exactly are “loan terms,” and how do they influence your loan repayment plan?
Let’s take a look at what exactly a loan term is so you can know what to expect if you borrow money and need to start repaying the loan amount.
A loan term is the amount of time you have to pay off a loan. This is also called the “duration of the loan” or “life of the loan.” This repayment period is established when you borrow money from a lender. For instance, a 30-year fixed-rate mortgage has a loan term of 30 years.
When you take out a loan, the loan term determines the length of time you have to pay off the loan as well as the amount of your monthly payments. For mortgage loans in particular, your repayment plan, along with what will comprise your monthly payments in terms of principal and interest, is called an amortization schedule.
The amortization schedule shows how your monthly payments apply to the overall loan balance over time. It outlines the amount you pay toward the principal balance and interest with any given payment. It also shows how your interest payments decrease throughout the life of the loan as you pay down the principal loan balance.
The type of loan you borrow and lender you work with can influence the length of a loan term. Loan terms for auto loans typically come in 12-month increments and can range from 2 to 10 years on average. Personal loans can have loan terms ranging from as few as 6 months to 12 years or longer depending on the lender and the loan. Some student loans have terms up to 30 years.
Mortgage loans also have short- or long-term lengths, but 15-year and 30-year loans are the most common types of home loans. The term length you qualify for may depend on whether you meet minimum borrower requirements, like your credit score and debt-to-income (DTI) ratio.
For a long-term mortgage, the principal balance is spread over a long period of time (for example, over a 30-year period). As a result, your monthly loan payments will likely be smaller compared to a short-term loan, but you’re ultimately paying more in interest over time. This can be a tempting option for borrowers who need smaller monthly payments for the life of the loan, if you don’t mind paying more in interest over time.
On the flipside, a short-term mortgage loan means you’ll be paying off the loan in less time. With a 15-year loan, for example, you would pay if off in half the time of a 30-year mortgage. Your monthly payments will be higher, but you’ll liquidate the loan sooner than a long-term loan, and you’ll pay much less in interest.
A loan term doesn’t just refer to the repayment period on a loan – it may also refer to the details of your loan agreement. Loan terms encompass the terms and conditions of the money you’re borrowing. Think of these as the rules or guidelines of the loan agreement.
Common loan terms and conditions include:
It’s important to carefully review your loan terms and conditions to fully understand what’s expected of you, and your lender, when entering into a loan agreement.
A number of conditions are worth looking out for when reviewing the terms of your loan. For instance, be cautious of anything related to balloon payments. A balloon loan usually has low or no monthly payments, and at the end of the loan term, the borrower is expected to make a large, one-time payment. This can be a risky option if you aren’t prepared to make the final payment when the loan term ends.
You may also want to be wary of language pertaining to defaults, especially for a home loan. Lenders may outline different loan terms – such as the number of payments you can miss – regarding what’s allowed before you enter default. If you default on your mortgage, your home may be at risk of foreclosure.
Understanding your loan terms and how they work not only helps ensure you can meet conditions and make payments on time, but it can also help you negotiate the terms with your lender.
Before committing to a lender, you may want to shop around and prequalify for a loan with multiple lenders. Prequalifying makes it easier to compare loan terms and rates to see who has the best offer for your situation before getting approved. You may be able to use the best offer you find to negotiate for even better loan terms with a lender.
You may also be able to negotiate the specific terms of a loan, such as your APR, monthly payment amount and other fees. Talking with a lender and negotiating even small changes to a loan’s terms can help save you thousands of dollars in the long run.
A loan term refers to the length of time you have to pay off a loan. Loan terms can also encompass specific terms and conditions established in your loan agreement. It’s important to understand both the term length and the rules of your loan to ensure you’re meeting all lender and loan requirements so you can ultimately pay back your loan amount properly and in a timely fashion.
If you’re ready to purchase or refinance a house, we’re here to help. Learn how to get a mortgage with our step-by-step guide.
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