Consolidation loan advertisements usually highlight several issues: the maximum value of liabilities committed, the interest rate, the amount of commission for granting the loan (so-called preparatory commission) and the long repayment period.
The loan period of up to 9 years – 10 years can be tempted by people who are currently struggling with too high installments for several loans.
However, it should be remembered that reducing the installment by extending the repayment period also results in an increase in the total cost of borrowing. This relationship can be illustrated with the help of two interesting examples.
The ten-year consolidation period is becoming more common …
Before presenting specific calculations, it is worth noting that the long repayment period is increasingly common for consolidation loans.
You can find out after checking the offer of several leading banks (see the table below). In the case of twelve lenders, the maximum lending period varies from 7 years (84 months) to 10 years (120 months).
It is worth realizing that even a seven or eight-year limit on the loan period does not prevent the consolidation of liabilities of a typical value.
Maximum extension of the repayment period is unlikely to be profitable
The effects of extending the repayment period were analyzed on the example of two consolidation loans (value: USD 20,000 and USD 50,000), which have fixed interest rates and preparation commission typical for the current offer of banks.
After taking into account the parameters of these two loans, we calculated the amount of a single installment and the sum of equal installments at different repayment periods (5 years, 6 years, 7 years, 8 years, 9 years and 10 years).
The sum of installments reflects the total cost of the loan, and a single installment indicates the level of the borrower’s monthly financial burden.
Changes in these values are particularly interesting when extending the repayment period by another year. In the case of the first consolidation loan (USD 20,000), extending the loan period by one year results in a 3% increase in the total amount to be repaid.
It should be noted, however, that the fall in a single installment with a longer repayment period is not identical. If the repayment period is extended from 5 years to 6 years, an increase in the sum of installments by 3% can be “converted” into a reduction of the monthly installment by 14%.
If the loan period is extended from 9 years to 10 years, the installment decreases by only 8%. A very similar situation also applies to the higher-value consolidation loan (USD 50,000).
Impact of extending the loan repayment period on installments and overheads
The information from the table above shows that with repayment periods increasing, debt breaking into more installments, it is less cost-effective.
The cost of increasing the number of installments remains the same, while each subsequent change results in a smaller decrease in the monthly payment. The same relationship can also be seen for other installment loans (e.g. cash loans, car loans, and mortgage loans).
The analysis suggests that the consolidation loan holder should not always strive for a maximum extension of the repayment period. Such a solution is beneficial for the bank (due to the higher total cost of credit), but it does not have to prove profitable from the borrower’s point of view.
The main purpose of a consolidation loan should be to reduce the monthly financial burden to a level that is acceptable and safe for the debtor.
If the amount of installments during consolidation lasting e.g. seven years suits the bank’s client, then it is worth considering whether spreading the debt over the following years (resulting in an increase in the cost of credit), indeed you are a good idea.