Term

Term summary:

• Term refers to the length of time over which a loan is scheduled to be repaid.

• Longer-term loans typically make monthly payments more affordable, while shorter-term loans typically have lower total costs over the life of the loan.

• You should compare loan terms to make the best choice for your needs.

Term Definition and Meaning

In finance, term refers to a specific period of time. When it comes to credit, the repayment term is the amount of time you have to pay back what you owe.

The repayment term is very important when borrowing money. It affects both the total cost of the loan and how affordable the monthly payments are. Knowing how the repayment term affects those things can help you choose the best loan for your situation. 

Key Attributes of Terms

Here are some common characteristics of repayment terms:

• Repayment terms can be expressed in months or years.

• Repayment terms on loans are typically set at the beginning of the loan.

• Loan terms are generally divided into a series of regular payments, usually monthly.

• The longer the term on a loan, the lower the regular payments are likely to be.

• Longer-term loans typically have higher interest rates than shorter-term loans.

• Longer-term loans are also likely to cost more in the long run.

Types of Terms

Different loans have different repayment term structures.

Fixed-term installment loans

This is the most common format for consumer loans, including mortgages, car loans, and student loans. The repayment period is “fixed,” which means set in advance. Payments are divided into equal amounts at regular periods (usually monthly) over the term of the loan. These loans are also called "closed-end" credit.

Variable term borrowing

Credit cards and lines of credit give you some flexibility as to the repayment schedule. There may be a minimum payment due every month, but you can choose to pay more some months than others. You can also add to the amount you’ve borrowed from time to time. Those choices can affect how long it takes to pay back what you’ve borrowed, and what the total cost of borrowing is over time. This type of borrowing is also called "revolving" or "open-ended" credit. 

Balloon payment loans

Loans with a balloon payment have a scheduled term for repayment. However, their payments are not identical through the loan's entire term. Instead, you make lower payments until the end, when a larger lump sum is due. This makes your initial payments more affordable. However, you must be able to come up with that large balloon payment when the time comes.

How the Repayment Term Affects Your Payments

The length of the term you choose affects the cost of the loan in a few ways:

• Longer-term loans generally have lower monthly payments. It’s easy to understand why. Longer-term loans let you spread the loan repayment over a longer time. 

• Shorter-term loans generally have lower interest rates. Long-term loans represent a higher risk to lenders than short-term loans. That’s why lenders typically charge higher interest rates on long-term loans. There are exceptions to this, so it’s a good idea to check out both long- and short-term rates before you borrow. 

• Shorter-term loans generally have lower total interest. With a longer-term loan, not only are the interest rates often higher, but they also require you to pay interest over a longer period. That usually adds up to higher costs over the life of the loan.

Given these characteristics, each type of loan has its advantages. Long-term loans make monthly payments more affordable. For example, without the availability of 30-year mortgages, far fewer people would be able to afford a home.

On the other hand, shorter-term loans (like 15-year mortgages) cost less in the long run. So, this can save you money as long as you can afford the higher monthly payments.

Over the course of repaying a loan, you may find that your circumstances change. That’s why refinancing can be a valuable option. It can allow you to change the term of your loan to better suit your needs.