Long-term debt has a number of characteristics that make it distinct from short-term debt financing. Some of these traits are advantageous for you as a borrower, while others pose potential challenges. Taking on too much long-term debt is risky, but it does offer advantages over paying cash for major purchases. Mortgages, equity loans, car loans, boat loans, major appliance financing, student loans and personal loans are among common long-term consumer loans.
Characteristics of long-term debt include a higher principal balance, lower interest rates, collateral requirement and more significant impact on your monthly cash flow.
Higher Principal Balance
Long-term debt typically has a higher principal balance than other debt obligations. This is because people don't usually get long-term loans for smaller purchases.
Mortgages are usually the most expensive purchase people make. Loans of $100,000 or more are common. Car loans of $5,000 to $10,000 are routine as well. The idea of taking on this amount of debt can be scary, but it is often the only way to make such large purchases.
Lower Interest Rates
Long-term debt usually comes with lower interest rates than short-term financing. This is because mortgages, car loans and boat loans are generally secured with the property as collateral to reduce the lender's risk.
While an unsecured personal loan or credit card may have rates ranging from 13 to 23 percent, depending on your credit, home loans in the 4 to 5 percent range are common as of February 2019. Car loans in the 4 to 6 percent range are also the norm for borrowers with decent credit.
Requirement of Collateral
Whereas personal loans, credit cards and store cards are usually available without collateral, you typically can't make a major purchase without securing the debt with collateral. This is because of the more significant risks to the lender of losses if you bail on a $100,000 to $200,000 home loan, as opposed to a $5,000 to $10,000 personal loan or credit card balance. By putting up your home, car or boat to get the long-term debt, you do have risks of loss to repossession if you don't keep up with the payments.
Impact on Monthly Cash Flow
Taking on long-term debt has a more lasting impact on your monthly cash flow. Committing $500 to $1,500 per month to a mortgage, $200 to $400 to a car loan and $300 to $600 on a student loan eats away at your monthly income pretty quickly. These debt commitments are on top of other living expenses like utilities, groceries, entertainment and household items.
High monthly debt commitments reduce how much money you can spend on vacations and entertainment, and they increase your potential for debt problems. While credit cards also affect monthly cash flow, it is generally a short-term commitment. Mortgages and car loans are more commonly considered in basic family budgeting.
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