Term loans are borrowings from banks or other financial institutions for a fixed tenor, where repayments are made over a period of time, in easy installments. The terms of the loan may vary from 30 days to 30 years as is agreed between the lender and borrower. The interest rates on term loans may be fixed or floating in nature.
Based on the tenor of loans, we can categorize them into short term loan and long term loan. The decision to choose between short term and long term loan results in the final loan amount borrowed and how much interest will be payable.
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Major Differences Between Short Term And Long Term Loans
- Loan Amount
The main difference between long-term and short term loans is the amount lent. Needless to say, the higher the loan amount, the longer it will take to repay it, in most cases. The lower amount of short term loans makes repayments easier and without getting in debt.
- Interest Rates
High-interest rates are charged on short term loans mainly to compensate for their short repayment period. Typically, short term loans are provided collateral-free making it riskier for lenders in case of non-payment of loans, which is again covered by charging high-interest rates on short term loans.
- Ease in Loan Approval Procedures
The main reason why borrowers apply for short term loans like a personal loan is because of the immediate liquidity offered by them. And therefore, the process involved in approving these loans by the lenders is quick and easy. Minimal documentation is required for short term loans.
Long term loans are approved only when all the eligibility criteria are met and the credit-worthiness of the borrowers is thoroughly assessed. In the case of secured long term business loans, the market value of these assets is assessed. Many times, short term funds are approved within 24 hours which is almost impossible in case of long-term loans.
The repayment tenor for short term loans is usually between 1 to 5 years. Whereas the tenor of long -term loans may vary between 10 to 20 years. The longer repayment time allows a business to spread its mortgage over a longer period of time.
A Long term loan is provided for a higher amount with longer tenor resulting in the repayment going on for longer periods. The lenders, therefore, request a collateral i.e. security for these types of loans. In case of any default from the borrower, the lender can recover their outstanding dues from the sale of such collateral. On the other hand, short term loans are usually unsecured and don’t require collaterals. However, in certain cases, they may need some indirect form of collateral - such as invoice discounting, account receivable funding, overdraft facility secured against fixed deposits, and so on.
- Need for Loans
A Short term loan is usually utilized for the company’s working capital requirements or operational expenses. Businesses essentially use long term funds to finance an asset purchase or an expansion or growth strategy. The output from these assets or expansion strategies is earned over a period of time, thus allowing repayment of loans in a structured and phased manner.
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Whether financing is required for a new property purchase or working capital requirement, the amount of money you borrow and interest rates are probably your top priority when deciding on the type of loan. You don’t borrow enough and it may lead you to need another loan. Borrow too much, and you may not be able to pay it back on time, notwithstanding whether it is a long-term loan or a short term loan. Ultimately, deciding between short term and long-term loans comes down to assessing your explicit need for finance.