Understanding Long-Term Loans

By Kelvin Jorgensen, Senior Vice President

Long-term loans aren’t usually top of mind when considering lending options. However, they do have some advantages over short-term and medium-term loans, including lower monthly payments and protection against increasing rates.

While there is no standard industry definition of a long-term loan, they usually span a repayment period of 15 to 20 years but can differ by banking institution and borrower preference. In comparison, short term loans usually range from six months to five years and medium-term loans somewhere between six years and fifteen years in length.

When considering a long-term loan, it’s important to know the lending options and common types of long-term loans offered across the industry, i.e., business loans, personal loans, mortgages and government-funded loans. Let’s look at each one in more detail.

Long-Term Business Loans

As a business owner and entrepreneur, a long-term loan might be one of the most important decisions, and investments, you’ll make to help grow your business. Both traditional banks and alternative lenders offer these types of loans. They usually require a good credit standing, and, typically, at least one-year of proven cashflow as a business to secure.

Long-term business loans usually have a lower cost than short-term or medium-term loans, on average they are five to seven times less expensive than other options and have a lower payment due the longer term. This makes them an optimal choice for expansion or development of your business, particularly if you’ve been in business for a few years and want to invest in growth.

It is important to note that most long-term business loans have more stringent requirements on credit, for the owner and for the business. And they typically require strong financials, a good to great credit history, and proof of an “established business.” The definition of an “established business” varies by bank, so it’s important to include this research when seeking out the best bank or financial institution for your needs.

Long-Term Personal Loans

Most long-term personal loans require collateral, but this isn’t a hard-and-fast rule. The terms of long-term personal loans depend upon the banking institution’s requirements and  your credit history. Many consumers use long-term loans for larger purchases such as boats, large weddings, medical expenses, student loans and cars—typically for purchases ranging from $10,000 and higher.

One of the main advantages of a long-term personal loan is a lower monthly payment. Because the total lending amount is spread over a longer period of time, the monthly payment will decrease significantly. For example, a $40,000 loan at 12.99% interest spread out over four years has a monthly payment of $1072.90 but the same loan amount spread out over 15 years has a monthly payment of $505.83.

These loan types usually offer a choice between a fixed interest rate and a variable interest rate. A fixed interest rate will be determined at loan inception and will carry through until loan payoff—providing a steady monthly payment over the life of the loan. A variable rate will adjust over the life of the loan because it’s based on an underlying benchmark interest rate, or index, that changes periodically.  This could be to your advantage if interest rates remain constant or decrease because the variable rate is generally lower than the fixed rate from the beginning or will decrease if rates fall but could also be a dis-advantage if rates increase because the variable could exceed  the  fixed rate for an extended period of time.

It is important to note that because the loan is spread out over a longer period of time, the total accumulated interest over the life-of-the-loan will be a higher amount than total accumulated interest of a short-term loan. Taking the example above, a four-year loan will accumulate approximately $12,500 in interest. That same loan spread out over 15 years will accumulate approximately $51,000 in interest. However, the longer repayment period allows you to maintain a lower monthly payment while paying extra when you can—so the flexibility of paying it off early and saving interest is an option you can exercise.

Mortgage Loans

A mortgage loan is probably the most familiar long-term loan in the market. Homeowners can take advantage of a 15-year or 30-year repayment term, and often times something in-between depending on the lender’s options. While mortgage loans offer many of the same benefits, pitfalls and flexibility of personal long-term loans, they differ greatly in loan type, funding, collateral requirements and the lending process.

The five most common types of mortgage loans are 1) conventional mortgages, 2) jumbo mortgages, 3) government-insured mortgages, 4) fixed-rate mortgages and 5) adjustable-rate mortgages. Conventional and government-insured loans are the most common type and usage depends largely on the buyer’s situation. Many second and third-time homebuyers choose the conventional loan because overall borrowing costs tend to be lower and the required down payment is flexible. However, the borrowing criteria is more stringent on these types of loans than government-insured mortgages, known as FHA, VA or USDA. These loans types vary in detail but provide the option of homebuying to borrowers who don’t have a large down payment saved up and don’t have pristine credit.

Government Issued Loans

The most common type of government issued loans are student loans. But there are other types of government loans, including loans for housing, first-time homebuyer programs (discussed in the mortgage paragraph above), home improvement and repair loans, loans to farmers, green projects and other various loan types that come and go with legislation.

Education Loans provide students a  way to fund schooling. Education loans are easy to qualify for, have competitive rates and offer a lot of flexibility once you get out of school, allowing you time to get on your feet and secured in your career field before beginning payments.

Home improvement and repair loans provide funding for the rehabilitation of a home. These usually come into existence after a natural disaster. The government also offers programs to reduce the amount borrowed to certain public servants such as law enforcement officers, teachers, firefighters, EMT’s and veterans.

Other types of government issued long-term loans include green projects—where local government will provide programs or incentives to help with energy-efficient upgrades like solar installations in a home or business. In a crisis, such as the mortgage crisis, the government offered refinancing programs to reduce payments or overhead to help keep homeowners in their homes and prevent default.

Do your own investigation

While a long-term loan has its advantages, it is also important that you look at your own situation and objectives and determine the right path. Shop different banking institutions, review lending options and determine the best source for funding your needs.