4 Steps for Choosing the Best Personal Loan Term Length

The length of a personal loan repayment term can have a big impact on your monthly payments, the total cost of your loan, and its affordability during different life phases. Knowing how loan terms work, the pros and cons of short-term and long-term loans, and the financial implications of term lengths can help you make the best financial decision for the present and the future.

Here are four steps to help you choose the right loan repayment term.

1. Learn about common person loan term lengths

In general, the most common personal loan repayment terms you'll find are two to seven years. This range applies to most uses, such as debt consolidation, credit card refinancing, home improvement, and major purchases. However, some lenders offer long-term loans with lengths of 10 years or more, depending on how you use the loan and its size. For example, LightStream offers personal loans with term lengths up to 20 years if you use the funds for home improvements.

2. Understand how term length affects your loan

Personal loan term lengths have a big impact on several aspects of your loan repayment:

• Monthly payment: Loans with shorter repayment terms have higher monthly payments, while loans with longer repayment terms tend to have lower monthly payments.
• Interest rate: Generally speaking, loans with longer repayment terms have higher interest rates than loans with shorter terms. Lenders tend to raise interest rates on long-term loans because longer repayment terms increase the risk of default.
• Interest paid: Your term length plays a crucial role in how much interest you pay. The longer your term, the more interest you'll pay over time.

How term length affects repayment costs

Lenders typically offer several different term lengths. As noted, the longer your repayment term, the higher your loan's APR (in most cases). And since you'd pay interest over a longer period of time (with a longer repayment term), that further increases the loan's cost.

The chart below shows APRs and estimated interest costs of three loan terms for a $10,000 loan:

In this case, choosing a five-year loan would cut your monthly payment by almost half compared to a two-year term. But you could end up paying more than four times as much in interest.

A personal loan calculator is a great tool for calculating how term length can impact how much interest you pay over the life of your loan.

3. Explore key differences between short- and long-term loans

Which loan length is best for you depends on which one of two views you take, says Jasmine Ray, CFP and founder of Tulsa-based Bamboo Financial Partners.

“There's the math answer — and then there's the real-life answer,” Ray says. “Mathematically, shorter loan terms usually mean lower total interest paid, since the balance is paid down faster and shorter terms often come with better rates.” However, if paying less interest over time means monthly payments you can't afford, a long-term loan is the right call.

Gloria Garcia Cisneros, a CFP and wealth manager at LourdMurray, noted that there's no one-size-fits-all solution to the short-term versus long-term personal loan debate.

“We remind clients that they can always opt for long-term loans and pay them off sooner if additional money becomes available,” Cisneros says. “Think about what you can reasonably afford without putting other obligations at risk and goals on the back burner. Ensure you weigh your budget, the cost of borrowing the money, and your forecasted financial goals.”

4. Know what to consider when choosing your term length

Choosing a personal loan term length involves several considerations that can impact your short- and long-term financial health.

Loan amount

Choosing the right loan amount is an important part of keeping your monthly payment and total interest costs low. If you're getting a personal loan for debt consolidation, simply add up your various loan and credit balances and request a loan amount equal to the sum of your balances.

However, if you're using your loan for a home improvement project — or any other project with potentially unknown or surprise costs — consider adding 5% to 10% more to the amount.

Annual percentage rate (APR)

Your loan's APR is a percentage that accounts for the loan's interest rate plus any upfront fees the lender charges. For example, a loan with an origination fee will have an APR that's higher than its interest rate.

Generally speaking, you want a loan without an origination fee — in this case, the APR would be equal to the loan's interest rate. An origination fee can reduce the amount you receive if it's taken out upfront from the loan amount.

Monthly payments

Your monthly payment directly impacts your monthly budget, so consider how much of a monthly payment you can honestly afford. Choosing a loan with the lowest monthly payment might give you the most budget breathing room each month, but choosing a slightly higher monthly payment could result in significant interest savings over the life of the loan.

Total interest costs

Looking at total interest costs is a long-term way to understand the impact of your loan. The low monthly payments that long-term loans offer can be hard to pass up. However, a longer term means you're making many more interest payments, which adds up to a higher total cost.

As you compare terms, try to find the borrowing sweet spot that offers a balance between the lowest monthly payments and the lowest total interest.

Present and future budget

Another consideration is how your budget could change over time.

For example, your income could dip considerably if you're working a contract job that concludes at the end of the year. If that's you, then you'll need to consider how you'll cover your monthly payment if you can't find a job immediately after your contract ends.

On the other hand, if you have a raise coming soon that will allow you to make bigger monthly payments, you may want to choose a shorter repayment term with monthly payments that your raise will offset.

Ask yourself the following budgeting and income questions:

1. Is your partner starting a new job soon that will increase your household income?
2. Are your bills set to increase soon because of a life event like a marriage or the birth of a child?
3. Are any of your insurance premiums set to increase soon?
4. Does your financial plan include upcoming increases to the amount you contribute to your retirement or investment accounts?
5. Are any payment plans you're making for past bills coming to an end soon?
6. Where are you at in your short-term and long-term financial plans?