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What are the Pros and Cons of Term Loans?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 16 November 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
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Term loans are loans that are extended with a specific repayment schedule and payoff date, while also carrying a variable or floating interest rate. In some circles, the term is also applied to loans with a structured set of monthly installment payments and a fixed interest rate. Loans of this type are often helpful in managing purchases that can be paid for in full anywhere between one and ten years. There are several benefits to this type of loan arrangement, including the ability to work the payments into a monthly budget. At the same time, loans of this type do carry some risks, including the potential for wildly shifting interest rates to turn a good deal into one that is not quite as beneficial as envisioned.

Many consumers will use term loans as a means of financing purchases that may be difficult to pay out of pocket but can be managed effectively with the use of loan from a bank or similar financial institution. The term loan option is often helpful when purchasing larger household appliances such as refrigerators or washers and dryers. In many cases, the rate of interest that is associated with the loan will be competitive with the interest rates associated with credit card accounts, making the loan a better financial option.

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Car loans are another example of term loans that many people utilize on a regular basis. The loans make it possible to obtain a quality vehicle without the need to pay a large amount of cash up front. Again, interest rates are often very competitive, especially for consumers with excellent credit. There are rarely any type of penalties for early settlement of the loan, an attribute that allows the consumer even more control over managing the debt obligation.

While there are a number of benefits associated with term loans, there are a few potential drawbacks to consider. For consumers who have less than perfect credit, the interest rates associated with the loan may not be as favorable as other options, such as a long standing credit card account with a fixed rate of interest that was earned during better financial times. When this is the case, managing the debt with the credit card account may be a better option, assuming the consumer has the discipline to set an equitable amount above the minimum due each month and retires the balance in a reasonable amount of time.

For term loans that are equipped with variable or floating rates of interest, there is also the possibility that as that interest rate is adjusted based on the current prevailing rate in the marketplace, the consumer may find that the interest applied to the loan balance is much more than anticipated. As a result, the consumer ends up paying more for the purchase than originally projected. The floating interest rate on most term loans also makes it somewhat harder to budget the payments on the debt, since the amount will fluctuate from time to time. For this reason, many consumers prefer to focus on locking in fixed rates that are expected to be advantageous for at least the majority of the loan duration.

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