Choosing between Short term and Long term loans

A loan is a common form of financing option in India but finding the right loan is no walk in the park. With a variety of financial institutions and an equally large number of financial products to choose from, it’s easy to get confused about which loan to choose from. Take the right loan from the right lender and you are geared to enjoy some happy moments. Get saddled with the wrong loan and you are sucked into dangerous cycle of mis-managed finances.

One of the main things to consider before taking a loan is its tenure. Depending on the reason why you are taking a loan, you can avail a short term or a long-term loan. The tenure of a loan determines the rate of interest applicable and the monthly repayment amount. Hence make sure that you look into the finer details of each loan type to understand whether it suits your requirement.

Let’s look at the most common types of loans – short term and long terms and understand the positives and negatives attached to each variety. Read on to know, which loan type is the best fit for you.
 

What are short term loans?

Short term loans have a validity duration of three years or less. One of its common variants is the payday loan - a loan that is given to tide you over till your next payday. This loan comes with minimal approval requirements with the loan being credited to you the same day or the next.

What are examples of short-term loans?

Before understanding the difference between short-term credit and long-term credit, you must first categorise loan products based on their repayment period. 
 

1. Personal Loans

   These loans are available for a maximum tenure of 60 months. However, depending on your budget and affordability, you can choose a repayment period of 12 months to 60 months. Personal loan approval does not require the pledging of any asset, and you can obtain up to Rs 5,00,000 depending on your income, the credibility of your employer, your age, and your credit score. The amount of your personal loan can go up depending on these factors.
    
   The minimum annual income requirement for this loan is Rs 1,80,000, and you must be between the age group of 21 and 58.
    

Also Read: What are Advantages and Disadvantages of Short-Term Loans
 

2. Two-wheeler Loan

   Another common example of short-term credit is a two-wheeler loan, which has a maximum payback period of 48 months. This loan product is available for a maximum loan amount of Rs 1,00,000 or a loan-to-value ratio of 95%, whichever is lower. Since the lender hypothecates your bike until you clear all of your outstanding debts, the interest rates on bike loans are slightly lower.
    
   This loan product's notable features include approval even with a low income, the inclusion of insurance and registration fees in the loan amount, and simplified eligibility requirements. However, before taking out a bike loan, consider the resale value of the two-wheeler. The higher the resale value, the lower the interest rate.
    

3. Credit Cards

   Credit cards are an example of revolving credit. And the amount borrowed must be repaid within 27 to 30 days. They do not have an interest rate. If you miss a payment, you will be charged a monthly fee of 1-2% of the unpaid bill value. Another disadvantage of credit cards is that using them for more than 30% of their limit regularly reduces your credibility.
    

What are long term loans?

Long term loans have validity of more than 3 years that can even extend up to 30 years. This loan can be either secured or non-secured; the former means security in the form of collateral or asset, such as a title to your car or your home. An unsecured loan comes without this requirement, but has higher interest rates as it is riskier for the lender.
 

What are examples of long-term loans?

Long-term loans usually include mortgage finance. These are–
 

1. Loan Against Property

   This fund is offered on the pledging of commercial real estate such as office space, manufacturing units, hotels, and so on. The maximum loan term is 15 years, and you can receive up to Rs 15 crores or 75% LTV, whichever is less. LAP can be used for any legitimate purpose. 
    

2. Home Loan

   Home loan is another common type of mortgage finance and long-term loan. You can use this loan for a new house purchase or construction or renovation of your existing house. Home loans are available for tenures ranging from 20 to 30 years, and they come with various tax advantages. 
    

Which loan should you avail?

Even though the answer to this depends on your immediate need, its also important to understand which type of loan is ideal for you.
Here are a few points to consider:
 

1. Purpose

   Short term personal loans are obtained for immediate requirement which includes the payment for purchases, emergency expenditures, requirements to fulfil working capital needs etc. These loans are easier to obtain. In contrast, long term loans are obtained for a longer goal or purpose which include the purchase of new house or plots, building of new infrastructure, purchase of machinery or expansion of business in a new geographical region. These loans take time to be processed and are a little difficult to obtain.

 

1. Cost

   The interest rate on a short term loan is higher as compared to that of a long term loan. Since a long term loan is spread over a longer period of time, the interest rate and processing fees for the same are much lower.

 

1. Debt Trap Risk

   There is a high risk of a debt trap in a short term loan. Because of the high interest rate & easy availability of finance, the borrower may never end up paying the loan completely and he may end up paying a huge amount of interest.

 

1. Eligibility

   The eligibility criteria for both the loans are different. Short term loans are easier to gain because of the quick process and limited documentation, whereas, long term loans are credit worthiness related. To be eligible for a long term loan, an individual has to show details of income, credit-score, the profitability of the business, and projected statements reflecting the positive numbers in the business.

 

1. Paperwork

   Short term loans can be applied for with limited paperwork or documents. This basically includes income proof, identity proof, address proof and ITR returns. In case of long term loans, the paperwork is extensive and a lot of documentation about the business and its owners are necessary to be submitted.

 

1. Pre approvals

   A short term loan can be pre-approved and this may or may not be possible for a long term loan.

 

1. Processing Time

   Short term loan processing requires limited time and efforts. In the case of a long term loan, there is a thorough processing and verification, which consumes time and requires additional effort. Due to the longer tenure, it is important for the lender to thoroughly inspect the documents before an approval is given.

 

1. Prepayment Penalty

   Short term loans carry a prepayment penalty due to the short tenure. There may not be such penalty in the case of a long term loan.
    

Also Read: How online personal loans are changing the whole financial industry?

Ultimately, the type of funding you require depends on your need or your business requirement. There are pros and cons in both the types of loan and it is important to carefully choose the best fit. Either way, it is important to ensure that the loan supports your business or your requirement in every manner possible.

Which loan do you prefer and why? We would love to hear from you in the comments!
 
Disclaimer: This post was first published on 27th January 2017 and has been updated for the latest information, freshness and accuracy.