When you refinance a loan, many of the terms and conditions of the loan will be different. For example, you may have a different interest rate and monthly payment amount. Another thing that you’ll have a chance to change is the repayment term length. This is a crucial decision and not one you should rush into.
But first, what is a loan repayment term length? Here’s a refresher.
A loan repayment term length is the amount of time you’ll take to pay off the loan completely with interest. It is also called the loan term or the life of the loan.
The most common loan terms are 10, 15, 20, and 30 years.
Let’s say you choose a loan term of 10 years. First, the accrued interest is calculated for 10 years. The amount you borrow + the accrued interest over 10 years is then spread equally into 120 payments. That’s 12 months x 10 years.
If you choose a loan repayment term length of 20 years, the payments are spread over 240 months.
The loan repayment term you choose will affect both your monthly payments and the total amount you pay.
When you choose a shorter repayment term, you’ll clear your debt earlier. You’ll also pay less in accrued interest over the shorter repayment term length. However, to clear the loan faster, you’ll have to make higher monthly payments.
When you choose a longer repayment term, you’ll take longer to pay off the loan. You’ll also pay more in accrued interest over the longer repayment term length. On the other hand, the longer-term means lower monthly payments.
Generally, it’s best to choose the shortest repayment term length. This saves you the most money in interest. The shorter the term, the less you pay in accrued interest. That said, this option will increase your monthly payments significantly. When choosing a shorter term, it’s important to make sure that you can afford the monthly payments. Missing a payment can have serious consequences. Not only will you pay more in late fees and penalties but you’ll also damage your credit score. This is the best option to choose if you can afford the higher monthly payments.
With a longer repayment term, the opposite holds true. Your monthly payments will be lower but you’ll take longer to be completely debt-free. By the time your debt is completely cleared, you will have paid much more in accrued interest. This is a better option for you if finances are tight. You may pay more over the long term but you’ll avoid the far more serious consequences of defaulting on payments.
When deciding the right loan repayment term length for you, the first thing to do is calculate your monthly payments. Use an online loan calculator and determine the monthly payments at different repayment terms. Also, calculate your monthly income and expenses to determine how much you can afford towards monthly repayments. This will help you choose the shortest right loan repayment term length that you’re comfortable with.
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