In our previous article we took a look at the advantages of long term loans. We thought it only fair to look at both sides of the coin, so to speak. So here are some of the disadvantages of long term loans. Like any financial product, there are always pluses and negatives.
The fact is that many struggle having a debt hanging over them for multiple years. It can affect stress levels and more. None of us want to be in debt of course, and for some purchases, long-term debt is unavoidable. For a mortgage as an example. But to use another example, taking out £5000 for home repairs and having to repay the debt over 3 years could cause more problems than it solves. Some people are fine with such a debt, it is subjective.
This is not a 100% definitive fact, but it is the case with most loans. If you take out a long term loan, a lot could happen in your life over the repayment period. Your financial situation could improve significantly, which would mean you may wish to pay off your long term loan. But it may not be that simple to do so. The terms and conditions of many loans specify that early repayment of a loan is not possible. At least not without additional charges that may not make it worthwhile. So as always we recommend you always read the terms and conditions in full before committing to any financial product.
On the surface, it may seem a better to deal with repaying a £5000 loan over 4 ears at 5% interest, compared to repaying it over a year at 10% interest. But you will over the course of the loan repayment period pay more in additional charges, as there are 4 times as many repayments. You may be fine with this, as the costs are spread out over a longer period, and this may suit your budget. But do be aware at what the total cost of a loan is before you take one out. And then decide if it worth your while proceeding.
If you have to make three repayments on a loan, then that is more likely to happen smoothly than having to make 48 consecutive payments, even if the payments are lower. A lot can change in life in that time. Repaying a loan can be great for improving your credit score. But defaulting on one has a very different consequence, and could see your score damaged for years to come. So you need to make a long-term commitment when taking out a loan over a number of years. It can be a lot riskier.
Fact is, if you’re borrowing via a long-term loan, you’re probably borrowing a significant amount of money. People don’t tend to borrow a few hundred quid then repay it over 3 years. A major disadvantage of long-term debt is that it limits an individual’s monthly cash flow in the near term. The higher your debt balances, the more you commit to paying on them each month. This means you have to use more of your monthly earnings to repay debt than to make new investments to grow. It also limits your ability to build up a safety net of cash savings to cover unexpected costs of doing business.