Long-term loans are taken for real estate, equipment, car, and other similar major purchases. The loan amount is taken for more than one year. These loans are paid off in quarterly or monthly payment schedules during a specified duration.
Typically, the long-term loan is greater than £10,000. However, the loan amount does not classify a loan as long-term. Any loan that is taken for more than one year is technically classified as a long-term loan.
Financial institutions tend to classify long-term loans into two categories:
Intermediate-term loans: Also known as medium-term loans, they typically are paid back between two to ten years in instalments.
Long-term loans: These loans are generally paid back between ten to thirty years. The loans are usually secured by collateral and are paid back in monthly or quarterly payments. Long-term business loans usually have terms that limit the amount of additional funds the business can take during the duration of the loan. In addition, businesses may be required to set amount certain percentage of profits to repay the loan.
Uses of Long-Term Loans
Long-term loans are usually used for major expenses such as buying a house, a car, or capital expenditures. The term capital expenditures refer to large expenses that generally improve income generating ability of a company. It is also used for the construction of buildings, roads, and other facilities by large contractors.
Generally, rates for long-term loans are relatively lower than for short-term loans. However, a borrower would have to pay greater interest rates and other charges on long-term loans.
Situations When It’s Not Beneficial to Take a Long-term Loan
In certain cases taking a short-term loan is better as compared to a longer duration loan. Start-up costs for launching a new firm or new product should be financed by taking short-term loans. Taking a long-term loan is not recommended in such a situation as there is no certainty at this point of time about the success of the business idea.
Another situation where short-term loans are more advisable is to benefit from seasonal discounts from the vendor. For instance, the vendor might offer discounts during Black Friday or Christmas Eve. A company can avail the financial incentive by small infusion of capital.
Also, businesses that want to purchase equipment for meeting temporary seasonal demands should utilise short-term loans to lease the asset. In this way, they won’t have much capital tied in capital expenses.
Long-term loans help businesses and individuals to make major purchases. The best benefit of taking longer duration loans is that it makes the instalment amount much more affordable as compared to taking the same amount of loan for a shorter duration. Another benefit, of utilising long-term loans is that they result in less money tied to making the loan payments. The saved money could be better utilised in other more lucrative investment avenues.
That being said, there are certain situations where it’s beneficial to take a shorter duration loan. It’s important to consider the pros and cons before selecting a particular type and duration of loan.