A loan that is set to be repaid in regular payments over a set period of time is called a term loan. Most term loans last from one year to ten years. Some term loans may last for more than 10 years. Usually, the tenure for a term loan is decided at the time of loan application by the lending institution or bank. Term loans can be categorised based on their tenure into short-term loans and long-term loans.
Customers have the option to choose between a fixed rate of interest and a floating rate of interest on the term loan. However, most banks reserve the right to choose it, particularly for short-term loans. A fixed rate of interest stays constant throughout the entire term of the loan. This means that the borrower will pay the interest based on the rate set at the time of application of the loan. This also means that the instalment amounts stay constant.
On the other hand, a floating rate of interest fluctuates with the market and economic conditions. This causes that the instalment amount to change as well. As a rule of thumb, a fixed rate of interest is advisable for a long-term loan while borrowers can benefit from a floating rate of interest for a short-term loan. However, there are several exceptions to this rule.