An Introduction to Long Term Loans
It is rare for a consumer or business to have enough cash on hand to invest in large and expensive items such as a house or car and long term loans provide the necessary debt financing for these purchases. Long term loans can be from three to twenty-five years in duration and in order to qualify a debtor must have a positive credit history, the ability to provide collateral, and capital. Provided that those criteria are met, a long term loan can minimize the effect on operational cash flow, a debtor can borrow at a lower interest rate, a business can minimize investor interference, and it is also an effective way to build credit worthiness.
Long Term Loan Advantages:
Cash Flow
Capital is a limited resource and investing large amounts into any asset or project limits the availability of capital for other investments. Long term loans minimize time spent saving for investments and investors are able to realize potential earnings sooner to help offset the cost. Although keeping some cash on hand is important to mitigate unexpected expenses, saving large lump sums is inefficient. Long term loans increase the flexibility of an investor’s limited capital by allowing for its distribution over multiple investments, and minimizing the immediate impact on operational cash flow.
Lower Interest Rates
Lending institutions assume a high degree of risk on long terms loans, which usually requires the borrower to offer collateral. Often, the asset for which the funds are being borrowed can act as that collateral. If the borrower defaults on their payments, that asset can then be seized, or repossessed, by the lender. The simplest example is a mortgage – a debtor borrows money to purchase a house and also uses that house as collateral. Until the date of maturity of that loan – where the debtor becomes the sole owner of that asset – defaulted payments will result in the borrower being evicted and ownership of the house transferring to the lender.
Minimize Investor Interference
Seeking private investors and issuing shares are common ways to raise money for potential investments. However, these are also ways of dividing ownership of the company and therefore redistributing control. Long term loans provide an opportunity to finance potential investments while maintaining control of the firm.
Build Credit
Generally, long term loans have a very structured payment process that has been designed to meet the payment capability of the borrower, notwithstanding unforeseen events. Therefore, making regular payments on a long term loan will allow an individual or a business to build their credit worthiness. For a business owner, building a business’ credit is important to rely less on personal credit for future debt financing.
Leasing
Leasing, most often applied to car financing, is a common form of a long term loan. The borrower pays to use the asset but is bound by the terms of the agreement. For example, on a car lease the car cannot exceed a certain amount of kilometres – this is to ensure that the lender can continue to use the asset should the borrower choose not to purchase it at a discounted rate after the maturity date. Leasing is beneficial for people or companies that either wish to have, or that require, continually updated versions of an asset.
Uses for Long Term Loans
It can be very advantageous to take out a long term loan for both a consumer and for a business. After the maturity date and when full ownership is assumed, the former debtor (and now owner) can use the asset and the positive credit they have developed paying for it for future borrowing. Thus, reliable debtors experience a compounding effect of the advantages of a long term loan.
