Loan Term Length: What Each Extra Year Costs

What the term is and where to find it

A personal installment loan is repaid in equal payments over a set period, and the Consumer Financial Protection Bureau notes that the period can run from a few months to several years. Offers usually state the term in months. On the Truth in Lending disclosure it appears in the payment schedule as the number of payments, their amount and when they are due.

Read the schedule, not only the headline. A loan with 60 payments is a five-year commitment, and the last payment can be a slightly different amount from the others because of rounding. If the offer shows only a monthly figure, ask how many of them there are.

Same $10,000, six terms: the payment and the interest

The table holds the rate at 14% and changes only the term. These are worked examples computed with the standard amortization formula, not offers from any lender; the terms a lender offers you depend on its own rules and your application.

Each added year lowers the payment by a smaller amount than the year before and adds roughly $780 to $910 of interest. Going from 24 to 36 months saves $138.35 a month; going from 72 to 84 months saves only $18.66 a month but still adds $905.28 of interest. Past a point, a longer term buys very little room in your budget at a real price.

Why the balance falls slowly on a long loan

Interest on an installment loan is charged on the balance you still owe. In the first month, $10,000 at 14% accrues $116.67 of interest whatever the term. On the 36-month loan, the rest of the $341.78 payment, $225.11, goes to principal. On the 60-month loan, only $116.01 of the $232.68 payment does.

The gap compounds. After 12 on-time payments, the 36-month loan has a balance of about $7,118.40, while the 60-month loan still owes about $8,514.95. After three years the 36-month loan is paid off; the 60-month loan still has about $4,846.38 to go. That matters if you plan to sell what you bought, refinance, or pay the loan off early, because the payoff figure is the balance, not the number of payments left times the payment.

These balances are worked examples that assume every payment arrives on its due date. Late payments leave more interest to pay and push the balance up.

When the longer term also carries a higher rate

The CFPB lists the amount and length of the loan among the factors a lender weighs when it sets the rate and terms, so one lender may quote a different rate for each term. Ask for the rate and APR at every term you are considering, not only the one shown first.

Suppose the lender quotes 14% for 36 months and 16% for 60 months. This is an illustration, not a typical spread. At 16%, the 60-month payment is $243.18 and the total interest is $4,590.80: $630 more than the 60-month loan at 14%, and almost twice the interest of the 36-month loan.

How to choose a term you can keep

1. 1 Start from your budget. Write down the payment you could still make in a tight month, after rent, food, transport and other debts.
2. 2 Find the shortest term whose payment sits at or below that figure. The loan term calculator shows the payment and interest for each term side by side.
3. 3 Ask for a quote at that term and one step longer, and compare the rates, not just the payments.
4. 4 Check the agreement for prepayment terms. If you can pay early without a charge, a longer term with extra payments keeps a cushion while you cut interest.

The extra payment calculator shows how much interest an extra amount each month saves. Before you rely on it, read prepayment penalties and the prepayment line of your disclosure, which must say whether a charge may be imposed for paying early.

Signs a term is too long for the purpose

• The loan outlasts what it paid for. A repair or an appliance that may need replacing in four years should not still be on a six-year loan.
• You picked the term to qualify. If only the longest term fits, the loan may be larger than your budget can carry; consider borrowing less.
• The payment looks small but the total does not. Compare the total of payments with the amount you receive before you sign.

State law can also shape the terms on offer, since some states tie their rate limits or maximum terms to the loan size. See the rules in your state.

Questions people ask