Loans: Long term v/s Short term Part II

Please read Part I

For this purpose banks want to get the money back as soon as possible. If you observe the chain of events, if say one or two defaults still bank will not be losing a great deal of money, its profit might come down a bit. Then why does bank gives long term loans for home loans? It is very logical for the banks to do this. The banks keep the interest rates low for home loans in order to lure the customers and ensure that they get a huge customer base. If many customers are lured to this home loan then they are in great profits.

Real estate market is generally profit making. The prices generally go north and most of the time it beats the inflation and gives the owner profits in the long term. Banks are interested in the repayment but it also does not worry much since it can get the house if a customer defaults and generally the bank gives 85% loan so it makes a cool 15% profit even if the customer does not pay a paise after taking the disbursement. Banks does not have a great deal of risk in house loan segment and hence it offers loans at lower rate.

You might question me that, auto loans are higher even though the automobile the person buys becomes a collateral security. But the value of the automobile depreciates by 10% once the vehicle is taken from the showroom and the value keeps depreciating and the recovery from such loans is not so very promising and hence the loans have higher rates and shorter terms.

Now, for a customer what is beneficial? Most of the customers want to repay the loan sooner which is a good thing but according to me, long term loans make sense. Assuming that I get Rs.100 as my salary and Rs. 10 as the EMI then it means 10% of my salary is spent on the loan. If the loan is for 12 months then I have to pay Rs.120. If in six months my salary becomes Rs. 150 n still the EMI is Rs. 10 then it means I am paying just 7% of my salary and I will have more money to save up and I can repay the loan amount in say 8 months the entire amount i.e. 100 + 16 = 116, this is actually lesser than actual amount.

If 6 months is short term and 1 year is long term in the above assumption then it clearly shows that I get an advantage if I repay the loan in long term assuming that I want to keep the EMI at 10% or lesser. It is always good to keep the loan repayment at less than 10%of your salary. This is done in order to save up more and also you get sufficient funds to invest and plan up. I prefer to keep this strategy as it helps you keep more money with you and less of head ache.

If you have any other views please share with me.

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2 thoughts on “Loans: Long term v/s Short term Part II

  1. pratik says:

    good article!
    however the example quoted probably is not realistic. very unlikely that your salary would get 50 % increment in the 6 months period :p

    ofcourse, i do get the drift…

  2. Natilia James says:

    You are right william, its depends on your business or job that much much money is generating from it according to that you can decide that witch one will be good for you. but if amount is not very high than long term loan is good. and in short term loan interest rate will always be high. See more details on this site

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