A loan is a common form of financing option in India but finding the right loan is no walk in the park. With a variety of financial institutions and an equally large number of financial products to choose from, its easy to get confused about which loan to choose from. Take the right loan from the right lender and you are geared to enjoy some happy moments. Get saddled with the wrong loan and you are sucked into dangerous cycle of mis-managed finances.
One of the main things to consider before taking a loan is its tenure. Depending on the reason you are taking a loan, you can avail a short term or a long-term loan. The tenure of a loan determines the rate of interest applicable and the monthly repayment amount. Hence make sure that you look into the finer details of each loan type to understand whether it suits your requirement.
Lets look at the most common types of loans – short term and long terms and understand the positives and negatives attached to each variety. Read on to know, which loan type is the best fit for you.
Short term loans: Short term loans have a validity duration of three years or less. One of its common variants is the payday loan - a loan that is given to tide you over till your next payday. This loan comes with minimal approval requirements with the loan being credited to you the same day or the next.
Long term loans: Long term loans have vailidity of more than 3 years, that can even extend upto 30 years. This loan can be either secured or non-secured; the former means security in the form of collateral or asset, such as a title to your car or your home. An unsecured loan comes without this requirement, but has higher interest rates as it is riskier for the lender.
Which loan should you avail?
Even though the answer to this depends on your immediate need, its also important to understand which type of loan is ideal for you.
Here are a few points to consider:
Purpose: Short term loans are obtained for immediate requirement which includes the payment for purchases, emergency expenditures, requirements to fulfill working capital needs etc. These loans are easier to obtain. In contrast, long term loans are obtained for a longer goal or purpose which include the purchase of new house or plots, building of new infrastructure, purchase of machinery or expansion of business in a new geographical region. These loans take time to be processed and are a little difficult to obtain.
Cost: The interest rate on a short term loan is higher as compared to that of a long term loan. Since a long term loan is spread over a longer period of time, the interest rate and processing fees for the same are much lower.
Debt Trap Risk:There is a high risk of a debt trap in a short term loan. Because of the high interest rate & easy availability of finance, the borrower may never end up paying the loan completely and he may end up paying a huge amount of interest.
Eligibility: The eligibility criteria for both the loans are different. Short term loans are easier to gain because of the quick process and limited documentation, whereas, long term loans are credit worthiness related. To be eligible for a long term loan, an individual has to show details of income, credit-score, the profitability of the business, and projected statements reflecting the positive numbers in the business.
Paperwork: Short term loans can be applied for with limited paperwork or documents. This basically includes income proof, identity proof, address proof and ITR returns. In case of long term loans, the paperwork is extensive and a lot of documentation about the business and its owners are necessary to be submitted.
Pre approvals: A short term loan can be pre approved and this may or mat be possible for a long term loan.
Processing time: Short term loan processing requires limited time and efforts. In the case of a long term loan, there is a thorough processing and verification, which consumes time and requires additional effort. Due to the longer tenure, it is important for the lender to thoroughly inspect the documents before an approval is given.
Prepayment penalty: Short term loans carry a prepayment penalty due to the short tenure. There may not be such penalty in the case of a long term loan.
Ultimately, the type of funding you require depends on your need or your business requirement. There are pros and cons in both the types of loan and it is important to carefully choose the best fit. Either way, it is important to ensure that the loan supports your business or your requirement in every manner possible.
Which loan do you prefer and why? We would love to hear from you in the comments!