What is tenure?
Tenure is the pre-specified duration or timeline for which a loan gets sanctioned. It is also a time during which a borrower has to repay the money borrowed under the loan. For a loan tenure to begin, a particular asset or collateral is held in exchange by the lending institution for the sanction of a loan amount. The pledged asset or collateral held by the lender is usually land or a building in exchange for which the loan amount gets sanctioned, or it can be the repayment capacity of the borrower. Tenures can range anywhere from a year to even 25/ 30 years, depending on the type of loan taken.
Different tenures for various loans
The tenure or timeframe of a loan depends on the type of loan taken. Loan tenures are of three kinds—short-term, mid-term, and long-term loans.
Short tenure
Short tenure loans are loans with a repayment tenure ranging from 1-3 or 1-5 years. Unsecured loans usually have a shorter tenure because the bank or lending institution sanctions the loan without the pledging of any asset or collateral in exchange. The bank only relies on the borrower’s repayment capacity, credit history, and other professional and financial details. This is why they want the loaned money back from the borrower without delay. However, unsecured loans are multi-purpose in nature, so the borrower can use the loan amount for any purpose, ranging from home renovation to marriage and higher education. Examples of unsecured loans include Personal Loans and credit card loans.
Mid-tenure
Mid-tenure loans have a repayment tenure ranging from 5-7 or 5-10 years. Secured loans, such as two-wheeler or four-wheeler loans, have a mid-term tenure. In mid-tenure loans, the lending institution sanctions the loan after pledging the asset purchased by the borrower. For instance, in a Pre-owned Car Loan, the collateral is the car itself. So, on the non-payment of a loan instalment or failure to pay after several reminders, the bank can seize the car/ vehicle to retrieve the costs of the loan. Other loan types that have a mid-tenure are Business Loans. Business Loans can also be short-tenured.
Long tenure
Long tenure loans have a repayment tenure ranging from 10-25 or 10-30 years. Secured loans, such as Home Loans, have a long-term tenure. In long tenured loans, the bank or lending institution gives the borrower a long repayment tenure because they take the home as collateral pledged to make good default and non-payment. The interest rates for long-tenured loans also tend to be lower.
How to choose the right tenure for your loan?
The ideal tenure for your loan depends on three crucial factors—your loan amount, your repayment capacity, the type of loan taken, and the interest rate applicable. Here is how you can go about it -
1. Understand the type of loan taken
Your repayment tenure will first depend on the type of loan you are taking. Loans are broadly categorised into secured and unsecured loans. Secured loans generally have a longer repayment tenure, whereas unsecured loans will have a shorter repayment tenure. So, for instance, if you have taken a Home Loan, your default repayment tenure would range from 10-30 years, and similarly, if you have taken a Personal Loan, your ideal repayment tenure would be one to five or seven years.
2. Take a look at your loan amount
The second step in choosing the right loan tenure is to look at the loan amount you are applying for. If you have applied for a small loan and are confident about repaying it in a few years, then you can opt for a short tenure. If you have taken a sizeable loan amount (say up to 6-10 times your monthly income), the appropriate repayment tenure would be mid-term or long-term.
3. Take your monthly income into account
This is the most important factor to take into consideration while deciding your tenure and the loan amount itself. Your financial health will dictate how easily and conveniently you can repay the sanctioned loan amount within the designated tenure. Making a list of your monthly obligations can help you decide how much you can set aside for repayment.
4. Check the interest rates for various tenures
You should choose your loan tenure based on the interest rates applicable on the loan. Interest rates depend on the type of loan taken, the timeframe, and the loan amount, either in combination or on a standalone basis. A secured loan will have lower interest rates than an unsecured loan. A short-tenure Personal Loan will have higher interest rates than a long-tenured secured loan. However, short-tenured loans can have a lower average cost of borrowing and an overall low-interest rate. Whereas long tenured loans can have a higher average cost of borrowing and an overall higher interest rate because the duration is spread out for a higher timeline.
Given the many factors that influence the appropriate tenure for a loan, it is best to consult an authorised financial advisor before making a decision.
Loan tenure vs EMI
EMI translates to equated monthly instalments. EMIs are monthly payments made to a lender or seller to repay an outstanding loan amount within the given timeframe or loan tenure. The percentage of EMIs payable by a borrower depends on the loan tenure and not vice-versa. Suppose you have taken a loan of ₹8 Lakh and the repayment tenure is three years. The EMI would be a result of the calculation between the loan amount, the repayment tenure, and the interest rate payable. There is a formula available to calculate the EMI payable for a particular loan. The standard EMI formula is - EMI = P × r × (1 + r) n/ ((1 + r) n - 1) where P stands for/ = Loan amount, r = interest rate, n = tenure in number of months. However, to save borrowers the hassle of manual calculation, most banks and lending institutions have an online EMI calculator with the formula already pre-set. In most cases of loan repayment, your EMIs are fixed by the bank or lending institution after consulting or making you aware of the dynamics behind the decision. However, borrowers sometimes get the option to choose between a couple of EMI options and the mode of EMI payment as well—monthly, three monthly, half-yearly, or yearly.
Does loan tenure affect credit score?
A credit score does not depend on the loan tenure unless you factor in the type of loan taken and whether you can pay your EMIs on time. For instance, if you take a Personal Loan for a short tenure but you are confident you have the financial commitment to repay the entire loan amount within the short duration, your credit score won’t get affected. However, if you have a pre-existing bad credit score and want to improve it, you can take a long tenure repayment and pay lower EMIs. All that the bank/ lending institution cares about is that you pay the EMIs on time. A longer tenure in unsecured loans can improve credit scores and the possibility of getting future loans approved. Another hasty step that could affect your credit score negatively is to pre-close your loan at one time. Early foreclosure of loans does not demonstrate your repayment capacity to the credit authority or lender. In fact, foreclosure attracts a penalty fee, called a foreclosure charge or pre-penalty payment. If it is a secured loan, then you will make a positive impact on your credit score. However, like unsecured loans, you have to pay your EMIs on time. So, ultimately, on its own, loan tenure does not affect credit score. Missed EMI payments do.
Final words
The tenure of a loan determines how comfortable you will be with your loan repayment terms. There is no golden standard of the ideal loan tenure, and the correct loan tenure will depend on factors, such as the type of loan taken, the interest rate payable, and your financial capacity. It would be advisable to consult a licensed financial advisor or institution to choose the loan tenure that will make loan borrowing and repaying a breeze.
