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16 JUNE, 2021

What is a Short term Loan?

A Short Term Loan is a financing option designed to cater to the immediate financial needs of businesses. It provides companies with the necessary funds to meet their short-term financial needs, such as operational costs, working capital requirements, and expansion plans. The loan tenure for Short Term Loans usually lasts three to five years and requires the borrower to repay the loan amount and interest before the loan tenure ends.

Advantages of Short Term Loans

  • Quick Access to Funds : When it comes to financing your business needs, short-term loans are an ideal option for those who require immediate funding. Unlike traditional loans that may take weeks to process, short-term loans can be approved within a few days or even hours in some cases.
  • Customizable Loan Terms : Short-term loans offer more flexibility compared to other types of loans. You can tailor the loan terms to your needs, including choosing the loan term length and the repayment schedule.
  • No Collateral Required : Another significant benefit of short-term loans is that they typically do not require collateral. Unlike traditional loans that may require you to put up your assets as security, short-term loans rely mainly on your creditworthiness and financial history.

Disadvantages Short Term Loans

  • Higher interest rates : Short term loans are often associated with higher interest rates than other loans. This is because lenders consider them to be riskier than longer-term loans. It's essential to be aware of the potential for high-interest payments, as they could significantly impact your startup's financial situation.
  • Shorter repayment periods : Short term loans generally come with shorter repayment periods than other types of loans. This means you'll have a shorter time frame to repay the loan amount, which can be challenging if your business is still in the early stages and generating limited revenue.

What is a Long term Loan?

If you don’t know what is Long Term loan is, Long term loans are ideal for individuals seeking extended repayment periods that align with their financial capabilities. These loans are commonly used for personal purposes, such as weddings, medical emergencies, and debt consolidation, and for more significant investments like homes or businesses.

The loan tenure means the period of a long term loan, which can span from 5 to 25 years. Consequently, long term loans offer numerous benefits, including access to more significant loan amounts and lower monthly installments, making them a favorable option for borrowers seeking manageable repayment plans.

Advantages of Long Term Loans

  • The interest rates are lower because the borrower commits to repay the loan over a longer home loan duration, and the lender benefits from the interest earned.
  • The eligibility criteria are limited, like personal loans, making the application process hassle-free.
  • Additionally, long term loans offer an opportunity to build credit through timely EMI payments, and some loans, such as home loans, provide tax benefits.

Disadvantages of Long Term Loans

  • They can impact monthly cash flow and require collateral, putting assets or homes at risk if repayments are missed.
  • Defaults can also drastically reduce the credit score, affecting future loan approvals. It is advisable to take long-term loans only during emergencies.

Situations Where Long Term Loans Can Be Useful

Long-term loans can be helpful in various situations where a borrower needs extended time to repay the loan amount. Education loans are an example where students can take loans for courses like engineering or medicine, which can be repaid over 30 years. Home loans are another advantageous long-term loan for individuals who need a substantial amount of money to buy a home and require a longer repayment tenure. Similarly, car loans and personal loans can also be taken for a more extended repayment period, allowing borrowers to pay back the loan amount in smaller installments over time.

Differences Between Short Term Loan vs  Long Term Loan

 

Long Term loan

Short Term Loan

Tenure

Long-term loans typically have a repayment tenure that extends beyond five years, with terms of up to 30 years.

Short-term loans typically have a repayment tenure that is usually five years or below.

Collateral

The majority of home loans are long-term loans that require collateral. The borrower cannot fully own the property used as collateral until the loan is fully paid off.

Short-term loans do not always need collateral. When the collateral is required, the asset can be uncollateralized quickly.

Interest rate

Long-term loans have a more extended repayment period and smaller monthly payments spread over several years, resulting in lower interest rates than short-term loans.

Lenders may charge you higher interest rates to get any value for a short-term loan.

EMI

The EMIs are usually lower in long-term loans.

The EMIs are higher to recover the amount in a short period.

Disbursement process

Long-term loans may have a longer processing time as banks or lenders usually thoroughly evaluate a borrower's creditworthiness and repayment capability.

Short-term loans are typically dispersed quickly because they involve smaller loan amounts and require minimal documentation.

 

 

Factors to Consider when choosing between Short Term & Long Term Loan

  1. Loan amount : Long-term and short-term loans differ based on the loan amount. With long-term loans, a higher loan amount generally means a longer repayment tenure, while short-term loans usually have lower loan amounts with faster repayment periods.
  2. Interest rates : Short-term loans usually have higher interest rates compared to long-term loans. This is due to the shorter repayment period, which makes them riskier for lenders. On the other hand, long-term loans may have lower interest rates as they have a more extended repayment period, and there's less risk of non-payment.
  3. Duration : Short-term loans have a repayment tenure between 1 to 5 years, while long-term loans have a repayment tenure ranging from 10 to 20 years. The extended repayment period for long-term loans allows businesses to distribute the repayment over a more extended period.
  4. Monthly income : Your monthly instalments depend upon the home loan tenure. A long-term home loan would mean lower EMIs, whereas a short-term home loan would lead to comparatively higher EMIs. Make sure that your EMIs are affordable, and do not exceed 30-35% of your monthly income. This will help you repay your home loan with ease and meet other expenses without any hassles.
  5. Age : Your age plays a crucial role in deciding whether to choose short-term or long-term loans. If you are in your 20s and have just started your career, you can consider availing of a long-term home loan. Your monthly income is more likely to increase as you gain professional experience, and this can help you repay your loan with ease. On the other hand, if you’re already in your late 40s or early 50s, you will have no other option but to opt for a short-term home loan. This is because banks provide home loans only till retirement age or for tenure up to 20 years.
  6. Objective of the purchase : If you wish to purchase the property with an investment objective, opting for a short-term home loan would be a better option. Whereas, if you are buying a house for self-use, you can go ahead with a longer repayment tenure. This will lower your home loan EMIs, and consequently, reduce the risk of default. Thus, you can comfortably reside in the house while making the home loan repayment.

Choosing the suitable home loan tenure is crucial as it can impact your monthly EMI outgo and total interest pay-out. Your monthly income, age, rate of interest, and objective of purchase determine whether to opt for a  short term and long term home loan. While a long-term loan may mean lower EMIs, a short-term loan may help you save on interest in the long run. Assess your needs and financial situation before making a decision.

 

Choosing Between Short Term and Long Term Loans

The decision between a short-term and a long term loan period depends on individual circumstances and repayment ability. Borrowers who prefer lower monthly installments and do not want to overburden themselves financially should opt for a long-term loan. However, those who want a quick disbursal and can bear a high-interest rate can choose a short-term loan.

Before going for either short term and long term financing, It is also essential to consider the borrower's age, as those nearing retirement age may face difficulty in availing of a long-term loan. Lenders may view such cases as high-risk, and applicants in their 40s or 50s may meet eligibility constraints for loans with longer repayment tenures.

Considering these points, you can understand the risk involved in opting for a long-term and short-term home loan. Want to get over the burden of paying EMIs sooner? Choose a short-term home loan. However, be ready to pay higher EMIs although, with a reduced overall interest amount. On the other hand, go for a long-term home loan if you cannot pay higher EMIs. While the interest paid will increase, you can pay smaller EMIs.

To sum it up, you must choose a home loan tenure that suits your repayment capacity! A home loan is a secured loan, wherein the purchased property acts as collateral. Therefore, in case you default on your home loan, the lender may seize your property to recover the loss incurred. Opting for a tenure that makes your EMIs affordable will reduce the chances of default. You can also get an estimate of your home loan EMI with the help of an online EMI calculator.

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Frequently Asked Questions

How to calculate short term loan

Determining the simple interest on a loan is a straightforward process. All you need to do is multiply the principal amount of the loan by the interest rate and the term. Simple interest is typically used for short-term or automobile loans, although some mortgages may also use this calculation method. Alternatively, you can use an EMI calculator to determine the simple interest on your loan.

How to get a long term loan

With digitization, lenders offer short term loan and long term loan both online and offline modes to avail of loans. Applying online can reduce processing time significantly, as it requires visiting the lender’s website and submitting the necessary documents. On the other hand, seeing the nearest branch of the lender and meeting the concerned officer in charge of loans is required for offline applications.

What is Tenure in a loan?

Loan tenure meaning the duration between the loan disbursal and the final payment of the EMI. Suppose your loan was disbursed on January 1st, 2022, and you made the last EMI payment on January 1st, 2025, your loan tenure would be considered three years.

Can I switch from a short term to a long term loan?

Yes, it is possible to switch from a short term loan period to a long-term loan. However, the process and feasibility of the short term long term switch depend on various factors, including the terms and conditions of your current loan, the lender's policies, and your creditworthiness.

Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.