Keep it short, stupid (or and simple). KISS, not just in writing, but in loan tenors too.
Longer is not always better. Not just in physical attributes and giftedness but in loan tenors too. They say you won’t feel it. I’ll say you’ll bleed before you know it.
Previously prescribed 3 to 6 month installment tenor for credit cards. Now let’s deal with loans.
Consider the following table, all assuming straight-line amortization:
Assuming same loan amount and same rate, longer tenor leads to lower amortization. Light on the pocket? You decide. Now see this.
Total Payments for the Whole Term and Total Interest Paid are staggering given the longer tenor. At 5 years, you end up paying almost double of what you borrowed. At 15 and 30 years tenors, you’ll bleed to death.
Effectively, a 1 year loan tenor is not really charged with 30% but 17% only. At 5 years, annual charge may be 19% and not 30%, but still cumulative interest payments almost double.
One may argue though that Examples 3 and 4 may be too exaggerated as tenors of 15 and 30 years are more applicable to home loans, with a lot lower interest rate since it has collateral. So here’s another example. Example 6 may be close to a usual bank auto loan while Examples 7 and 8 for a home loan, with loan value at Php 1M (very small property).
Still the same story actually. At 30 years, cumulative interest paid is PHP1.6M, 160% the initial loan amount.
So the next time you prefer longer tenors, think again. Loans can be used as powerful financial tools and leverage if you are informed.
It’s not just a matter of low amortizations that you cannot feel. You should also look at how much you will pay for the entirety. So the shorter, but still within your cash flow, the better.
If a long tenor cannot be avoided, make sure to request for rescheduling to shorter tenor every time your capacity to pay increases.
Explore whether partial prepayments (or advance payments on top of monthly amortization) can be made (e.g. during bonuses) to avoid paying too much interest.