Long-term financing is a common need when you want to make large purchases, such as with a home, car or boat. You may also get a home equity loan or personal loan to cover education, home renovation or business start-up costs. You need to understand the advantages that come with the ability to repay these borrowed funds through installments over a long period of time.
Low Monthly Payments
The monthly payments on long-term financing are usually low. If you borrow $100,000 to buy a house at a 5 percent fixed interest rate with a 30-year repayment period, your monthly payment of principal and interest is $536.82. These small monthly installments improve your ability to budget effectively for other monthly expenses, including utilities, groceries, clothes and kids' needs.
Improved Cash Flow
Closely related to small monthly payments as an advantage is improved cash flow. Using a loan for a large purchase is akin to borrowing against your future income. In the previous example, you basically commit $536.82 per month of future income to debt repayment. Compared to shorter-term financing, though, this is modest. If you wanted to pay off your home loan more aggressively with a 15-year term, your monthly payments at the same 5 percent rate would be $790.79. This is much more restrictive to your monthly budget.
Greater Borrowing Potential
One of the more critical benefits of long-term repayments is the ability to borrow larger amounts. Banks compare your monthly income to existing debts and the potential structure of a new loan. Spreading out loan payments over a long-term makes it easier for you to afford the monthly payments. This is part of the appeal of longer mortgage terms or car loan repayments. You can buy more and spread the costs out in smaller increments over time.
Interest rates on long-term building or asset loans are usually low when you secure the loan with the asset. The low cost of borrowing adds justification to the financial benefits of repaying the debt in small installments over time. A home equity loan with a 10 to 15 year repayment period typically offers a better interest rate than credit cards or personal loans with shorter repayment periods. Additionally, the interest on mortgages and home equity financing is usually tax deductible. According to "Kiplinger" many homeowners are actually better off taking a 30-year mortgage at a slightly higher interest rate than a 15 to 20 mortgage largely because of the tax deductions.
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