How to Choose the Right Personal Loan Term

When applying for a personal loan, the interest rate often gets the most attention. However, the loan term—how long you have to repay the loan—is equally important and directly impacts both your monthly budget and the total cost of borrowing. Choosing the right term requires balancing affordability with overall cost efficiency, and the optimal choice varies based on your financial situation and goals.

Understanding Loan Terms

Personal loans in Australia typically range from one to seven years, with three to five years being the most common. The term determines how many monthly payments you'll make and, consequently, how large each payment will be. A longer term spreads the repayment over more months, making each payment smaller. A shorter term concentrates repayment into fewer months, making each payment larger.

However, there's a crucial trade-off: while longer terms reduce monthly payments, they increase the total interest paid over the life of the loan. You're borrowing the money for more time, so you're paying interest for more time. This can add up to thousands of extra dollars.

The Mathematics of Loan Terms

Let's look at a concrete example. Consider a $20,000 personal loan at 9% interest:

3-year term: Monthly payment of approximately $636. Total interest paid: approximately $2,900. Total cost: $22,900.

5-year term: Monthly payment of approximately $415. Total interest paid: approximately $4,900. Total cost: $24,900.

7-year term: Monthly payment of approximately $320. Total interest paid: approximately $6,900. Total cost: $26,900.

The difference is striking. Choosing a 7-year term instead of a 3-year term reduces your monthly payment by $316, making the loan far more manageable month-to-month. But you'll pay an extra $4,000 in interest over the life of the loan. That's a significant premium for payment flexibility.

Factors to Consider When Choosing Your Term

Your Monthly Budget: The first consideration is what you can realistically afford. There's no point choosing a short term with payments that stretch your budget to breaking point. Financial stress from unaffordable repayments can lead to missed payments, credit damage, and a debt spiral.

Analyse your monthly income and expenses carefully. A comfortable loan payment should leave room for savings, unexpected expenses, and some discretionary spending. Many financial experts suggest that total debt payments (including any existing debts) shouldn't exceed 30-40% of your gross income.

Your Financial Goals: Consider what you want to achieve in the coming years. If you're saving for a home deposit, planning a career change, or expecting reduced income, a lower monthly payment might be valuable even if it costs more in the long run.

Conversely, if you're in a strong financial position and want to minimise total costs, a shorter term makes sense. Being debt-free sooner provides financial freedom and flexibility for future opportunities.

Job Security and Income Stability: If you have a very stable job with predictable income, you might feel comfortable committing to higher monthly payments. If your income fluctuates or your job security is uncertain, lower payments provide a safety buffer.

The Purpose of the Loan: The nature of what you're borrowing for can inform term selection. A car loan, for instance, shouldn't extend beyond the useful life of the vehicle. A holiday loan might feel burdensome if you're still paying for a trip three years after you took it.

Shorter Terms: Pros and Cons

Advantages: Lower total interest paid, debt freedom sooner, builds discipline with finances, and psychological satisfaction of faster progress.

Disadvantages: Higher monthly payments that may strain budget, less flexibility for unexpected expenses, and potentially higher risk of missed payments if income disruption occurs.

Longer Terms: Pros and Cons

Advantages: Lower monthly payments that are easier to manage, more breathing room in your budget for other expenses or savings, and reduced stress from debt obligations.

Disadvantages: Higher total interest costs, longer period of being in debt, potential for the loan to outlast the usefulness of what was purchased, and temptation to take on additional debt due to lower payments.

The Middle Ground Strategy

Many borrowers find success with a middle-ground approach: choose a longer term for lower required payments, but make extra payments when possible. This gives you the security of affordable minimum payments while allowing you to reduce interest and pay off the loan faster when circumstances allow.

Before choosing this strategy, confirm that your loan allows extra repayments without penalty. Many Australian personal loans do, but some fixed-rate products charge fees for paying off early. Variable-rate loans typically offer more flexibility for extra payments.

Using Our Calculator to Find Your Ideal Term

The best way to choose your loan term is to model different scenarios and see the actual numbers. Use our personal loan calculator to experiment with different terms. Enter your loan amount and interest rate, then try various terms to see how monthly payments and total interest change.

Start by determining the maximum monthly payment you can comfortably afford. Then find the shortest term that keeps payments within that limit. This approach minimises interest while respecting your budget constraints.

Remember to consider potential changes in your circumstances. If you expect a salary increase or other positive financial change, you might be comfortable with higher payments. If uncertainty lies ahead, build in more buffer.

Final Considerations

There's no universally "right" loan term—only the term that's right for your specific situation. A young professional with rapidly growing income might thrive with aggressive short-term loans, while someone with variable income might prudently choose longer terms for security.

Whatever term you choose, the key is making an informed decision. Don't simply accept the lender's suggested term without understanding the implications. Run the numbers, consider your circumstances, and choose a term that balances monthly affordability with long-term cost efficiency.