In essence, loans are financial tools that help close the gap between your current financial capacity and your financial objectives. The amount of money needed, the time horizon, the urgency, the level of priority, and other factors can be used to distinguish between distinct financial goals. Similar to this, the loans needed to finance the goals must have various terms and interest rates to better match particular results. Long-term loans and short-term loans are the two broad categories into which loans can be placed. The registration process, repayment terms, interest rates, and other factors for these loans vary.
Let us take a deep dive into understanding how these two kinds of loans work-
Short-term Loan
- Loans that are used to fulfil a temporary financial need or even a small business expense are called short-term loans. These loans are so termed based on their quick turnaround or repayment. In most cases, such loans need to be paid off within a year, give or take a few months. Short-term Personal Loans, merchant cash, payday loans, invoice financing, etc are some examples of short-term loans.
- Short-term borrowings loans are generally suitable for temporary or minor financial mismatches. For example, your laptop may require replacement, but it’s the end of the month and you’re facing a cash crunch. For such an expense, you may opt for a short-term Personal Loan and repay the same within a year.
Benefits of Short-term Loans
The following are the benefits of short-term loans:
- A quick fix to your finances
Regardless of your financial preparedness, life may throw you a curveball with an unexpected financial expense that may not be in a position to pay for. In such times, a short-term loan can come to your rescue. These short-term borrowings can give you a financial cushion when you need them the most. - Upgrade your credit score
A short-term loan can help you build a good credit history that might come in handy if and when you avail of a long-term Personal Loan in the future. Thus, if you want to borrow for bigger expenses like buying your own home, you can start by taking and managing short-term loans. - Shorter approval process
Short-term loans generally have a quick approval process. The requirements for such loans are generally uncomplicated since the amounts are generally small and the duration is brief. And given the minimum documentation required, the loans can be processed quickly. - Quick and hassle-free repayment
Since these loans are generally taken for a provisional need, the loan amounts are typically small and manageable. Thus, it’s easier to set a repayment schedule. The loan can be repaid in bite-sized instalments within or even before the deadline. In fact, given flexibility around EMIs, monthly instalments can be designed in a manner that doesn’t disturb or disrupt current finances.
Also Read: 5 Easy Steps to Get a Personal Loan
Long-term Loan
As we move through life, there are many milestones we wish to accomplish. Goals like buying your own house, financing your child’s education abroad, etc are things that require substantial funds. More often than not, it’s very difficult to support these wishes just by dipping into savings. For such goals, you require significant credit support. This is where taking a long-term loan can be helpful.
A long-term loan is a debt that is offered for a long tenure. The repayment schedule for such loans typically exceeds 24 months and can go up to 30 years. Such debts are secured, which means the loan is sanctioned against the collateral provided. Since the loan is given for an extended time frame and is secured against collateral, the interest rates are generally reasonable. Home loans, education loans, car loans, etc are some examples of long-term loans.
Benefits of Long-term Loans
The following are the benefits of long-term borrowings:
- Borrow a large amount
Long-term loans allow you to borrow a substantial amount in the first instance. There is no need to disrupt your investments or empty your savings account to fulfill crucial goals. Long-term loans help you fund expensive but necessary purchases like owning a house, without it affecting your cash flow. Further, a significant purchase comes with its own set of associated costs that we don’t take into account. For e.g. owning a new home will also entail paying for a myriad of expenses that we overlook like utility bills, interiors, property taxes, maintenance bills, etc. Thus, a longer tenure loan assists in managing all these recurring expenses. - Affordable repayment
Long-term loans can be repaid over a longer period, which largely translates into lower monthly repayments. This cost then becomes manageable, allowing your monthly budgets to be reasonably set. Thus, long-term loans are an attractive option for people who want to restrict their monthly expenses and earmark a larger proportion of income towards savings and investments. - Low-interest rates
As explained earlier, long-term loans generally involve sanctioning a large principal amount that is secured against collateral. They also have longer payment tenures. Given these features, long-term loans typically offer lower and competitive rates of interest.
Short-term Loan vs Long-term Loan
Here’s the comparison between short-term and long-term borrowing:
- Tenure and Interest
The tenure and cost of loans are negatively correlated- which means that they move in the opposite direction. Thus, if the tenure is short, the interest rates offered are comparatively higher and vice versa. By extension, short-term loans typically charge a higher interest rate as compared to long-term loans. - Need for Collateral
Long-term loans involve higher amounts paid over a longer period. This is why in this case, lenders require assurance in the form of security in exchange for the loan. In the event the borrower defaults on the loan, the outstanding amount can be recovered by liquidating the collateral. In contrast, short-term loans are largely unsecured as they involve smaller amounts that are expected to be repaid over a short tenure. - Eligibility Requirements
Short-term borrowings are considered less risky by lenders. Therefore, they only have minimal documentation in the form of identity and income proof. In comparison, lenders face a higher risk of non-repayment in the case of long-term loans. Thus, lenders have to be convinced of the borrower’s ability to repay the loan. This involves presenting numerous documents to the lender for verification and scrutiny. Though the process differs across banks and financial institutions, largely a borrower will be required to furnish their IT return documents, salary proofs, bank statements, and property documents among other things. These documents serve as proof of a borrower’s creditworthiness and eligibility for accessing long-term loans. - Duration
The repayment tenure for short-term loans is generally within the range of 1-3 years. The duration for repaying long-term loans can go range anywhere from 5 years to 30 years depending upon the purpose of the loan. - Speed of approval
Short-term loans are approved and disbursed to your account quickly, sometimes even within a day given that they require minimal documentation and entail modest loan amounts. In comparison, the approval process for long-term loans is very long since it involves stringent background checks and a thorough review of documents. The loan will not be disbursed unless the lender is confident about the borrower’s creditworthiness and repayment capability.
Conclusion
Short-term and long-term loans both have their benefits and flaws. The borrower must weigh the pros and cons and decide which loan will be effective based on their requirements, purpose, and ability to repay the loan.
