Loans are essentially financial instruments that can bridge the gap between your current financial ability and financial goals. All financial goals are not the same and can be differentiated based on the funds required, time horizon, urgency, level of importance, etc. Similarly, loans required to fund the goals have to come with different tenures and interest rates to align better with specific outcomes. Broadly, loans can be categorized into two buckets: short–term or short-term borrowing and long-term loans. These loans differ based on the registration process, repayment tenures, interest rates, etc
Let us take a deep dive into understanding how these two kinds of loans work-
Short-term Loan
Loans that are used to fulfil a temporary financial need or even a small business expense are called short-term loans. These loans are so termed based on their quick turnaround or repayment. In most cases, such loans need to be paid off within a year, give or take a few months. Short-term Personal Loans, merchant cash, payday loans, invoice financing, etc are some examples of short-term loans.
Short-term borrowings loans are generally suitable for temporary or minor financial mismatches. For example, your laptop may require replacement, but it’s the end of the month and you’re facing a cash crunch. For such an expense, you may opt for a short-term Personal Loan and repay the same within a year.
Benefits of Short-term Loans
The following are the benefits of short-term loans:
1. A quick fix to your finances
Regardless of your financial preparedness, life may throw you a
curveball with an unexpected financial expense that may not be in a
position to pay for. In such times, a short-term loan can come to your
rescue. These short-term borrowings can give you a financial cushion
when you need them the most.
2. Upgrade your credit score
A
short-term loan can help you build a good credit history that might
come in handy if and when you avail of a long-term
Personal Loan in the future. Thus, if you want to borrow for
bigger expenses like buying your own home, you can start by taking and
managing short-term loans.
3. Shorter approval process
Short-term loans generally have a quick approval process. The
requirements for such loans are generally uncomplicated since the
amounts are generally small and the duration is brief. And given the
minimum documentation required, the loans can be processed quickly.
4. Quick and hassle-free repayment
Since these loans are generally taken for a provisional need, the
loan amounts are typically small and manageable. Thus, it’s easier to
set a repayment schedule. The loan can be repaid in bite-sized
instalments within or even before the deadline. In fact, given
flexibility around EMIs, monthly instalments can be designed in a
manner that doesn’t disturb or disrupt current finances.
Also Read: 5 Easy Steps to Get a Personal Loan
Long-term Loan
As we move through life, there are many milestones we wish to accomplish. Goals like buying your own house, financing your child’s education abroad, etc are things that require substantial funds. More often than not, it’s very difficult to support these wishes just by dipping into savings. For such goals, you require significant credit support. This is where taking a long-term loan can be helpful.
A long-term loan is a debt that is offered for a long tenure. The repayment schedule for such loans typically exceeds 24 months and can go up to 30 years. Such debts are secured, which means the loan is sanctioned against the collateral provided. Since the loan is given for an extended time frame and is secured against collateral, the interest rates are generally reasonable. Home loans, education loans, car loans, etc are some examples of long-term loans.
Benefits of Long-term Loans
The following are the benefits of long-term borrowings:
1. Borrow a large amount
Long-term
loans allow you to borrow a substantial amount in the first
instance. There is no need to disrupt your investments or empty your
savings account to fulfill crucial goals. Long-term loans help you
fund expensive but necessary purchases like owning a house, without
it affecting your cash flow. Further, a significant purchase comes
with its own set of associated costs that we don’t take into
account. For e.g. owning a new home will also entail paying for a
myriad of expenses that we overlook like utility bills, interiors,
property taxes, maintenance bills, etc. Thus, a longer tenure loan
assists in managing all these recurring expenses.
2. Affordable repayment
Long-term
loans can be repaid over a longer period, which largely translates
into lower monthly repayments. This cost then becomes manageable,
allowing your monthly budgets to be reasonably set. Thus, long-term
loans are an attractive option for people who want to restrict their
monthly expenses and earmark a larger proportion of income towards
savings and investments.
3. Low-interest rates
As explained
earlier, long-term loans generally involve sanctioning a large
principal amount that is secured against collateral. They also have
longer payment tenures. Given these features, long-term loans
typically offer lower and competitive rates of interest.
Short-term Loan vs Long-term Loan
Here’s the comparison between short-term and long-term borrowing:
1. Tenure and Interest
The tenure
and cost of loans are negatively correlated- which means that they
move in the opposite direction. Thus, if the tenure is short, the
interest rates offered are comparatively higher and vice versa. By
extension, short-term loans typically charge a higher interest rate
as compared to long-term loans.
2. Need for Collateral
Long-term
loans involve higher amounts paid over a longer period. This is why
in this case, lenders require assurance in the form of security in
exchange for the loan. In the event the borrower defaults on the
loan, the outstanding amount can be recovered by liquidating the
collateral. In contrast, short-term loans are largely unsecured as
they involve smaller amounts that are expected to be repaid over a
short tenure.
3. Eligibility Requirements
Short-term borrowings are considered less risky by lenders.
Therefore, they only have minimal documentation in the form of
identity and income proof. In comparison, lenders face a higher risk
of non-repayment in the case of long-term loans. Thus, lenders have to
be convinced of the borrower’s ability to repay the loan. This
involves presenting numerous documents to the lender for verification
and scrutiny. Though the process differs across banks and financial
institutions, largely a borrower will be required to furnish their IT
return documents, salary proofs, bank statements, and property
documents among other things. These documents serve as proof of a
borrower’s creditworthiness and eligibility for accessing long-term loans.
4. Duration
The repayment tenure
for short-term loans is generally within the range of 1-3 years.
The duration for repaying long-term loans can go range anywhere
from 5 years to 30 years depending upon the purpose of the loan.
5. Speed of approval
Short-term
loans are approved and disbursed to your account quickly, sometimes
even within a day given that they require minimal documentation and
entail modest loan amounts. In comparison, the approval process for
long-term loans is very long since it involves stringent background
checks and a thorough review of documents. The loan will not be
disbursed unless the lender is confident about the borrower’s
creditworthiness and repayment capability.
Conclusion
Short-term and long-term loans both have their benefits and flaws. The borrower must weigh the pros and cons and decide which loan will be effective based on their requirements, purpose, and ability to repay the loan.
