How Long Are Personal Loan Terms?

Getting a personal loan is easy enough for many consumers. Too easy if you count those ubiquitous predatory payday loan agencies that prey on people’s desperation.

The challenge is getting a loan that fits your budget; one you can repay without missing payments; and one that limits the amount of interest you pay over the length of the loan.

“Loan terms can vary, but for personal loans, they tend to be shorter than autos or other collateralized loans,” Trevor Smith, Corporate Branch Manager at Wasatch Peaks Credit Union, said. “For most institutions, the max term for personal loans is four years. The term could also be shortened due to credit factors, or the amount of history that the borrower has.”

How Does Term Length Affect the Life of the Loan?

Generally, the shorter the term of a personal loan, the lower the interest rate and the less you pay in interest. That part of the equation is simple, but the key is finding the sweet spot between limiting the amount of interest you will pay and having a monthly payment that will not break your budget or create another debt spiral that damages your credit score.

A loan you can barely afford on a monthly basis is a rabbit hole you don’t want to start down. Before you end up needing a second loan to pay off other accumulating debts, review your monthly expenses and your expected income during the length of the loan.

Then shop around for loan terms that you can safely manage, keeping in mind that while the monthly payment might be manageable, the total cost can increase significantly the longer the repayment period.

“Borrowers selecting long-term loans to reduce monthly payments often become locked into compounding traps that mimic predatory amortization schedules,” Chad Cummings, CEO of Cummings & Cummings Law, said. “A 72-month loan for $18,000 at 17.9% APR results in $13,607 of interest, yet the first 36 months pay down less than $5,000 in principal.

“Miss a single payment, and late fees, penalty interest, and credit score damage will render the borrower ineligible for refinancing or balance transfer options. By month 40, many are still underwater.”

How Are Personal Loan Terms Calculated?

That actual math formula for calculating payments on a personal loan is so complicated that lenders routinely offer personal loan calculators online.

You plug in the loan amount, the interest rate (APR) of the loan and the length of the repayment period and the online calculator will give you the monthly payment amount and total loan cost.

A shorter-term loan will carry a higher monthly payment but cost you less in the long run. A longer-term loan will be easier on the monthly budget but typically carries the higher interest rate because there’s more risk to the lender. You will pay more over time, sometimes significantly more.

For example, a $5,000 loan at 15% over two years costs approximately $818 in interest and carries a monthly payment of $242. That same $5,000 and 15% rate over five years will cost you $2,137 in interest with a monthly payment of $119. So, stretching out the loan an additional three years will cost you $1,319.

Pay attention to how much of each payment goes toward principal and interest and keep in mind the overall cost of the loan can include assorted fees including, in some cases, prepayment penalties.

“For the most part, the terms for personal loans are fixed for that specific amount of time,” Smith said. “The only fees that might be involved would be late fees. As long as it does not happen often, late fees won’t affect the term.

“These late fees may report on credit though, depending on how late the payment was. Pre-payment fees might be involved but are rare at least for credit unions.”

It’s important to project your income over the length of the loan. Is your income stable enough that you foresee being able to make the same payment in two or three years?

If you’re in the probationary period of a new job, for instance, or a new owner just bought your company and has promised changes, it might not be the best time to commit to repaying a longer-term loan.

Factors to Consider When Choosing Personal Loan Terms

In the best-case scenario, you answer the need to borrow money with a strong credit score and some credit history that convinces lenders that you’re a good bet to make on-time payments.

Even better, you have the income to afford the loan over the length of the terms.

Banks and credit unions want your business if you meet those standards. If you don’t, that’s when taking out a personal loan becomes riskier and requires you to do even more homework.

Before committing to a loan, nonprofit credit counseling is a good place to do an assessment of your finances. Credit counselors will examine factors that can greatly affect your chances of qualifying for an interest rate that doesn’t put you at a high risk of missed payments.

How much you owe on a monthly basis (car, mortgage, rent, credit cards, other loans) and what percentage of your income that debt represents (the debt-to-income ratio) is an important factor in how lenders decide what loan terms to offer individual borrowers.

Can you manage the loan process yourself? Sure. Many people do. But depending on the financial commitment required, don’t be afraid to solicit advice. Especially if you don’t have a strong credit score.

“Most personal loan applicants underestimate how underwriting algorithms penalize them for behavioral flags they cannot see or dispute,” Cummings said. “Lenders now routinely use machine-learning models that assign proprietary risk scores based on browser fingerprinting, device ID, and metadata such as the time of day the application is submitted.

“A consumer who applies at 2:15 a.m. from a prepaid mobile phone while toggling between tabs may be coded as high-risk, triggering rates above 26% APR… even with a 720 credit score and stable income!”

Cummings warns that lenders may deny or inflate loan terms due to undisclosed factors.

“These algorithmic overlays fall outside Fair Credit Reporting Act protections, making them nearly impossible to challenge,” he said.

Are Short or Long Loan Terms Better?

Short-term loans traditionally are considered better than long-term loans, but that answer isn’t at all helpful, because it’s 100% dependent on a borrower’s circumstances and financial need.

Short-term loans typically carry less stringent qualifying standards since the risk to the lender is mitigated by the term length (six months to a year on average) and the amount borrowed (significantly less than a longer-term loan.)

If you have good credit and can make the higher monthly payments that come with shorter-term loans, you can limit the amount of interest you’ll pay.

But shorter is not always better, especially in the case of payday loans, where borrowers are charged for every $100 loaned and face exorbitant interest rates that often put them in a spin cycle to financial doom.

If you are already struggling to pay down your debt month to month, adding a short-term loan with a higher monthly payment can be counterproductive at best and seriously damage your credit score due to late or missed payments.

A long-term loan is often best for a borrower seeking a larger amount of money, or those who may not want to put stress on their budget with yet another high monthly payment.

Good credit is often a prerequisite to getting a long-term loan you can handle. Longer-term loans come with greater scrutiny because they’re assessing a borrower’s ability to make payments over a number of years.

“When deciding whether to apply for a longer- or shorter-term loan, you should first look at interest rates,” Smith said. “The longer the term, the more you will pay in interest since it is calculated on a daily basis. Other things to consider might include the amount of the loan, or the payment that fits your needs.”

The Bottom Line

If you have a good credit score and can prove yourself a reasonable risk to lenders, qualifying for a personal loan from a bank, credit union or online lender can be a fairly seamless process.

Short-term loans will cost you more per month but save you interest in the long run. Long-term loans will increase the overall cost of the loan but make the monthly payments friendlier.

It’s not just important but crucial that you take the time to research lenders and get prequalified. When you make a formal application for a loan or a new credit card, the lender will do a hard check of your credit that temporarily causes your credit score to drop. Prequalifying provides the information you need without the ding to your credit.

Perhaps most importantly, you should bring to the loan process a complete understanding of your monthly expenses. Taking a loan you can barely afford – one that makes paying off your other debts more difficult – does you no good in the credit score department.

If you need help budgeting or paying down debt that is preventing you from taking out a loan at a livable interest rate, reaching out to a nonprofit credit counseling agency can save you money and stress.