The article helps to understand the meaning of long term loans, the features of loans, and the advantages and disadvantages of long term loans. Also, it cites a few examples of long term loans to give the readers a better understanding of the concept of long-term loans.
Let us first understand the meaning of long-term loans. It is a loan repaid by the borrower to the lender over a considerable period extending beyond 3 to 30 years. Some long-term loans include home loans, car loans, education loans, personal loans, etc. When considering long-term loans, it’s important to weigh the benefits of lower payments against the potential drawbacks of higher overall interest costs over time.
Long-term loans are considered the most popular type of credit in the financial sector. With the emergence of technology and easy and hassle-free banking, many people opt for home or car loans. These loan amounts are enormous, and the loan borrowers will have to repay the loan amount along with interest. Features of long-term loans may differ based on the reason the loan has been opted for. Long-term loans usually come with pre-payment options; hence, customers can repay the entire loan amount before the stipulated time and do not have to bear the burden of the loan for long tenures.
Some documents required for sanctioning long-term loans are permanent address proof of the applicant, identity proof of the applicant, applicant’s salary slips, bank account statements of the applicant, proof of income of co-applicant/guarantor, and duly filled optional guarantor form.
Examples of long-term loans
Let us now cite a few examples of long-term loans.
- Loan for pursuing higher studies: Students who want to opt for higher studies in India and a foreign country can take student loans or education loans. The amount of the loan and the interest rate may vary depending on the lending entity and the course for which the applicant is taking the loan.
- Loan for a home: Home loans are taken by several individuals for a new home. The applicant must submit collaterals to the bank, and a guarantor is needed to sign the loan application. Applicants get two options for the rate of interest on the loan amount.
- Loan for a car: Unlike in yesteryear, many people dream of a car, but they cannot afford to a car because they do not have sufficient cash. Herein lies the importance of a car loan or auto loan. Since cars are regarded as luxury items, the interest rate on a car loan is also high compared to a home loan. However, cutthroat competition among the lenders of car loans has compelled banks to keep the interest rate relatively lower for car loans. Car loans come with pre-payment options, but one must pay a pre-closure fee in the case of some banks. There are still other banks that do not charge any penalty fee for car loan pre-payment.
- Personal Loans: Personal loans usually have a long tenure. The interest rate is also high as these loans are mainly unsecured, and the borrower does not have to submit any collateral to avail of the loan. Hence, if a borrower is a defaulter, banks do not have the option to replenish funds from collaterals declared.
- Small Business Loans: Individual customers and companies can avail of long-term loans for expanding their business or purchasing heavy machinery. These loans are called small business loans. Small business loans are provided by all major public sector and private sector banks.
- Long-term Payday Loans: Long-term payday loans are ideal for fulfilling the crucial financial needs of customers who wish to repay the loan amount in small instalments over an extended repayment period.
Features of Long-Term Loans
- In long-term loans, like a home loan or car loan, the loan amount is usually higher.
- Since the repayment duration of the loan is higher, banks and other lending entities mostly impose relatively lower interest rates on long-term loans.
- Since the loan amount is much higher in loans than in other types of loans, the borrowers usually need to submit collaterals to the lenders. This helps the banks recover the lost cash if a borrower defaults on loan repayment.
- Long-term loan repayment usually happens in equated monthly instalments spread over a substantial time period. The monthly instalments consist of two components, namely, the principal and the interest.
- An individual can avail of tax benefits on repayment of a long-term loan, depending on the loan type. For instance, an individual can claim tax benefits on loan repayment if he opts for a home loan. However, if an individual opts for a car loan, he is not eligible for any tax rebate/exemption since a car loan is considered a luxury loan.
Advantages of Long-Term Loan
There are several benefits of long-term loans. Some of them are as follows:
- As we all know, capital is not an unlimited resource and investing a large amount of money in any asset or project restricts capital available for other investments. Long-term loans help improve the flexibility of the limited capital of an investor by allowing disbursals to multiple options for investments. At the same time, it minimises cash crunch by managing cash inflow, for that matter of fact.
- Usually, lending institutions assume a higher risk on long-term loans, making it necessary for the borrower to provide collateral. Quite often, the asset for which the loan is being taken can itself be used as collateral. If the borrower fails to make payments, the lender can either seize or transfer the ownership of the asset.
- One advantage of long term loans is that they can help borrowers establish a strong credit history and improve their credit score over time, as long as they make their payments on time.
- Long-term loans give a scope to manage potential investments; thus, an investor can look forward to long-term business objectives.
- Usually, long-term loans come with a structured repayment process. In long-term loans, making regular payments will facilitate an individual or a business to build a credit rating. A business owner must build business credit to depend less on personal credit for debt financing in the future.
- Leasing, a concept frequently used in car financing, is a common type of long-term loan. The borrower pays for using the asset, but he must abide by the terms and conditions of the agreement. For example, in the case of a car lease, the car will not be able to go beyond certain kilometres to ensure that the lender can continue using the asset if the borrower is reluctant to it at a discounted rate after the date of maturity.
Disadvantages of Long Term Loan
Like advantages, there are also some disadvantages of loans.
- One of the biggest Disadvantages of long-term loans is that it affects the monthly cash flow of an individual since the repayment has to be done every month. The higher the loan amount, the more the individual needs to repay every month. Hence, it is advisable not to take long-term loans unless there is an emergency or a crisis.
- The majority of loans call for collateral or security. Borrowers of long-term loans usually mortgage property as security to avail of the required finance at reasonable interest rates. The interest rate on secured long-term loans may be less than that on unsecured loans, but your asset, say, for example, your home, may be at risk if you cannot repay the loan.
- If an individual misses an EMI on a long-term loan, it will drastically reduce his credit score. This will also affect his future loan sanctions.
Hence, we can conclude that long-term loans come with associated risks and rewards, and hence, it is important for an individual to think before opting for such a loan. While long term loans can provide financial flexibility and stability, it’s important for borrowers to carefully consider their ability to make payments over the long term and to choose a loan with favorable terms and conditions.