Personal loans are unsecured credit instruments that come with flexible tenures. Lenders often allow borrowers to choose a tenure that best fits their repayment capacities. While opting for a personal loan, the importance of choosing the right tenure cannot be ignored, for the tenure you pick will determine your average cost of borrowing. The impact of tenures is more pronounced in the case of home loans due to larger amounts involved — a home loan of Rs 30 lakh at an interest rate of 9% for a tenure of 20 years would see you paying more interest than the initial principal.
As surprising as this may sound, you realise that tenures have quite an impact, don’t you?
As for personal loans, the most commonly available tenures are between 12 months and 60 months. So technically, you wouldn’t see yourself paying an interest that exceeds the principal. That said, there are multiple aspects that need to be considered while choosing the ideal tenure. Let’s take a look:
Your loan amount
To begin with, the amount you wish to borrow should be the first parameter to influence your loan tenure. If your loan amount is small, say 2x times your monthly income, it definitely doesn’t make sense to pick a long tenure. The calculation is simple – longer tenures mean lesser monthly repayment amounts but more interest over the course of your tenure. So with a loan amount of just 2x times your monthly income, it doesn’t make sense to unnecessarily bloat up the interest on your loan.
If your loan amount is higher, say upwards of 4 times your monthly income, it makes sense to choose a longer tenure. By doing so, your monthly repayment amounts are reduced, and you also have the option to pre-close your loan at a nominal charge. But then again, if your income is decently high and lets you save adequately, you can opt for a shorter loan tenure and refrain from paying additional interest as your tenure progresses.
The interest rate you’re offered is almost always going to depend on your credit health. A good credit score with a good repayment history that doesn’t contain defaults or multiple instances of late payments will often attract a lower rate of interest, much in line with risk-based pricing models adopted by lenders. If you are offered a low interest rate, it makes sense to pick a shorter loan tenure to avoid paying more interest (note that longer tenures attract higher interest payments).
However, with a bad credit score and a poor repayment history, you might want to pick a longer tenure, as high interest rates coupled with shorter tenures don’t make for the ideal combination – they only work to increase your monthly repayment amounts, not quite adding up to benefit you. Personal loan interest rates ideally fall in the range between 11% p.a. and 24% p.a., but can be more in the case of some lenders.
While taking into account the interest rate, if your income is high and your loan amount is about 2x times your monthly income, choosing the ideal tenure will also depend on other budgetary demands and obligations that you deal with every month.
Your monthly budgetary constraints
If your monthly expenses are high and make for a percentage of over 60% of your monthly income, you might want to choose a longer loan tenure to reduce the quantum of your monthly repayment amounts. Here again, you’d end up paying more towards interest as your tenure progresses, but you have the option to accumulate reasonable savings month-on-month, and eventually pre-close your loan. A shorter tenure will mean higher monthly repayments, leaving you with little room to save enough.The writer is Founder & CEO of Qbera.com