The tenor of any loan type, besides the rate of interest and monthly installments, is an important consideration. It’s crucial to choose the right loan repayment term because it affects the cost of borrowing. Given your current financial situation and loan requirement, you must determine the best period to repay the loan. Continue to know what loan tenor is, 5 factors that determine your home loan tenor and more.
What is a loan tenor?
Tenor is the time remaining before a financial contract expires. They sometimes use it interchangeably with the term maturity, although the terms have distinct meanings. They use tenor in relation to bank loans, insurance contracts, and derivative products.
They often use tenor in relation to bank loans and insurance contracts. Whereas they more often use the term maturity when describing government bonds and corporate bonds. Colloquially, the two terms’ meanings are alike. Besides that, they may use them interchangeably for different financial instruments.
They also use the term tenor in relation to non-standard financial instruments, such as derivative contracts. In this context, they often use it when describing the riskiness of a particular security.
A future contract with a long tenor, for example, could be dangerous because its value could still fall significantly. Shorter tenor derivatives would also be less risky. Buyers of high-tenor assets will typically demand compensation as lower prices or higher risk premiums to compensate for this perceived risk.
Some investors may systematically avoid assets with tenors longer than the stated time, depending on their risk tolerance and financial objectives. A corporation with short and medium-term liquidity needs might gain and sell debt instruments having tenors of five years or fewer. They might make adjustments in this case based on the perceived creditworthiness of the counterparties. For example, a corporation might accept a five-year tenor from high-credit-rated counterparties while limiting tenors from low-credit-rated counterparties to three years or fewer.
Tenor vs. Maturity
Tenor and maturity have different connotations from a technical standpoint. While tenor refers to the time left on a contract, maturity relates to the length of the contract when it was first signed.
For example, a ten-year government bond issued five years ago would have a 10-year maturity. Its tenor, or the time left until the contract expires, would be five years. In this way, a financial instrument’s tenor decreases over time while its maturity remains constant.
Case study of Tenor
Alex is the CFO of a publicly traded company with a mid-size market capitalization. They must guarantee that the company has adequate operating capital to carry out its activities as part of their obligations.
Alex accomplishes this by purchasing and selling short and medium-term financial securities with maturities ranging from one to five years. They do so in the corporate bond market and with many counterparties in over-the-counter derivative transactions.
Alex’s portfolio currently contains various products with five-year maturities from highly creditworthy counterparties. These securities have a tenor of two years because they were purchased three years ago. They also included instruments from counterparties with lower credit ratings in their portfolio. In order to mitigate counterparty risk, they limit the maximum tenor of these securities to three years.
In a credit default swap, tenor is essential since it aligns the remaining term of the contract with the maturity of the underlying asset. They must match the maturity of the contract and the asset in a properly structured credit default swap. Integration is unlikely if the tenor and the maturity of the asset are incompatible. Furthermore, cash flow coordination (and, as a result, yield computation) is only achievable when the tenor and asset maturity are connected.
5 factors that determine your home loan tenor
For both the lender and the borrower, a home loan is a long-term investment. Most people cannot purchase a home with a single payment. As a result, for a home loan, the tenor is just as significant as the interest rate. In this post, we’ll look at the elements that influence the length of a house loan.
1. Interest rate
One of the most significant aspects of any loan is the interest rate. It is the amount of money a person will pay back to the lender besides the principle borrowed. The money earned by the financial institution on the principle lent to them refers to the borrower as the interest rate. They accommodate financial institutions in allowing borrowers to select a tenor, with the longer the tenor, the lower the interest rate. This allows the borrower to pay a lower monthly EMI that they can comfortably manage.
2. What they use the loan for
They consider it while deciding the loan amount. For example, if a person takes out a loan to renovate their home, he or she may be eligible for a loan with a tenor of ten years. However, if a person takes out a home loan to gain land and build a house, they may be eligible for a loan with a tenor of up to 30 years.
3. Age of the property
The underwriter can employ a structural expert to study the building, its location, the number of years it has existed, and the materials used, especially if purchasing a used apartment or detached house. Several factors may affect the term of the home loan.
4. Credit score
If the borrower has a bad credit score, several financial institutions will shorten the term. Banks view such debtors as a risk since a low credit score shows poor credit management in the past payment of dues. They’ll try to get the money back as soon as possible, which will alter the tenor.
5. Age of borrower
The age of the borrower(s) has a significant impact on the length of the house loan. If the borrower is young, say 25 years old, he or she will be eligible for the maximum tenor, which is 30 years with most institutions. An older borrower may not be eligible for a long tenor or may be required to take on a co-borrower.
In addition, for combined home loans, financial institutions use the elder borrower’s age as the base age. If the borrower is younger and has a later retirement age, the tenor can be longer; otherwise, it will be shortened.
Frequently Asked Questions about Tenor
What Does Tenor Mean?
They refer to the time until a financial contract ends as the tenor. It’s frequently used interchangeably with “maturity.”
What Is Tenor in Banking?
In banking, tenor refers to the time it will take the borrower to repay the loan plus interest. A home loan term can range from 5 to 20 years, with certain institutions allowing up to 25 years.
What Is the Maximum Tenor?
Depending on the project and its debt servicing capacity, the loan tenure is normally between 5 and 25 years, with a maximum of 30 years.
What Is Tenor Basis Risk?
Tenor basis risk arises when a basis swap occurs. Even if they change the price on the same day, in the same currency, and against the same benchmark, difficulties could develop if they re-price for different periods or tenors.
Maintaining a regular cash flow and appraising the riskiness of a contract require an understanding of the tenor of any financial instruments a company may have, such as a short- or long-term derivative.