Why Lenders Push Shorter Loan Tenures for High-Risk Borrowers: A Smart Move for Everyone Involved

Considering that you are a small business owner in Mumbai with your Kirana store affected by increasing costs and changing levels of demand. Would you be able to raise sufficient working capital quickly through a loan to buy additional products for the upcoming festive season? You go to your bank or NBFC and are approved for a loan to help with your working capital, but they are saying it must be paid back in 1 year rather than 5 years, as you’d anticipated. This is very frustrating! However, this is actually not about lenders being greedy. This is about how lenders evaluate risk on an ongoing basis and how you can repay this loan now vs. later, and the overall effect of this on your long-term financial health. The current state of India’s lending environment, with technology companies disrupting the traditional banking model, is making it more likely that high-risk borrowers will be offered shorter loan terms.

Through my time working with both personal finance and MSME (micro, small and medium enterprise) loans, I have seen many examples of how lenders place high-risk borrowers with shorter loan terms for the protection of their financial institution as well as to protect you from falling into a debt trap. This post is intended to provide a better understanding of why lenders use shorter loan terms and how it benefits both lenders and borrowers.

Understanding Risk in the Indian Lending Game

So, what makes someone a high-risk borrower in India? It’s easy to think they’re just not responsible, but stuff happens – job loss, health problems, or a bad economy can all play a part. When lenders decide if you’re high-risk, they often check things like your CIBIL score, how steady your income is, and how much debt you have compared to your income. For instance, if you’re an IT worker with a salary in Delhi and you’ve had the same job for a while, you’ll probably get a personal loan with a pretty good interest rate for about five years. But if you’re a freelance graphic designer in Bengaluru making money on commission, you might be seen as riskier since your income changes, and you might have less time to pay it back.

Essentially, the risk associated with these borrowers depends on the likelihood of default. The Bank of India reported that Non-Performing Assets peaked at just over 11% in 2018, creating significant obstacles for the banks that provided the loan. After the COVID-19 pandemic, lenders implemented more stringent guidelines based on the current levels of RPPI established by the Reserve Bank of India (RBI), which required lenders to establish higher levels of provisioning for the higher-risk borrowers. Based on the aforementioned background and study data from companies such as Bajaj Finserv and Lendingkart, a “high-risk” borrower could have anywhere between a 20% to 30% chance of defaulting on their loan repayment.

Why Shorter Loan Tenures Reduce Risk for Lenders and Borrowers

By reducing loan terms to shorter timeframes of typically 1-3 years, instead of 5-7 years, lenders have greatly reduced their exposure over time. In the event that things don’t go well for a borrower, lenders will have recovered the majority of the principal back sooner, which decreases potential losses. This is very similar to renting out a vehicle; for example, if you had a nice car and lent it out to a person just starting their driving career, you would expect them to give you a large security deposit, as the risk is very high. Providing shorter repayment periods is not punitive; it is a sensible measure, especially given the volatility of income that the 40% of India’s unorganised workforce encounters. Some areas of rural Uttar Pradesh or Bihar rely on their crops for a living; thus, lenders only provide a maximum term of 18-24 months on farm loans due to the risk of defaulting on loans due to monsoon rains.

How Shorter Tenures Boost Repayment Capacity

Now, let’s talk repayment—the lifeblood of any loan. High-risk borrowers often have stretched finances: maybe EMIs already eat 50% of your take-home pay, or cash flows fluctuate like monsoon rains. Lenders spot this via bank statements and ITRs. A longer tenure might lower monthly EMIs (say, ₹10,000 vs. ₹20,000), tempting you to borrow more. But does it really help?

Not always. Shorter tenures force discipline. Take Priya, a teacher in Lucknow, supplementing income via tuition. Her CIBIL dipped to 650 after a family wedding loan. Applying for a ₹2 lakh personal loan, she wanted 48 months (₹5,500 EMI). The lender offered 24 months (₹10,000 EMI). Why? Her repayment capacity analysis showed irregular bonuses; longer terms risked default midway.

Mathematically, it’s compelling. For a ₹5 lakh loan at 15% interest:

• 5-year tenure: Total interest ~₹2.4 lakh, EMI ~₹11,900
• 2-year tenure: Total interest ~₹1.1 lakh, EMI ~₹24,500

Yes, the EMI doubles, but you pay 50% less interest and exit debt twice as fast. Lenders know high-risk folks benefit from this “skin in the game.” RBI’s emphasis on debt service ratios (under 50% ideally) pushes this—shorter terms keep you within limits, building a track record for future loans. Gig economy stars like Zomato delivery partners thrive here: 12-month personal loans match peak earning seasons.

It’s even easier to see this in MSMEs (micro, small and medium enterprises), where it is being stated that a Chennai-based tailor will borrow ₹10 lakh for machines for a period of 18 months instead of 60 months. The reason? Because they will have seasonal sales, meaning that cash flows will be high during Diwali and lower during summer months, the shorter cycle will align repayment schedules with cash inflows and increase on-time payments by approximately 25-30%. (IFMR Research)

The Financial Stability Angle: Building Wealth, Not Chains

Beyond risk and repayment, shorter tenures foster financial stability—a lender’s subtle gift to you. Long loans lock you in, turning assets into liabilities. Ever heard of “EMI slavery”? In India, household debt hit 40% of GDP in 2023, fueled by easy 7-year car loans. High-risk borrowers, with thinner margins, amplify this.

Shorter terms free you quicker. Rajesh, a Noida cab driver post-COVID, took a ₹3 lakh gold loan at 24 months (12% interest). He cleared it in 18, thanks to Ola’s surges. Result? His credit score jumped 100 points, unlocking a business loan for his own auto-rickshaw. Lenders foresaw this: by reducing tenure, they enhance your net worth trajectory.

This stability ripples out. Stable borrowers mean fewer NPAs, letting lenders offer better rates economy-wide. RBI’s 2022 master circular on lending mandates assessing “sustainable debt levels.” Shorter tenures ensure that your post-loan balance sheet strengthens, with less interest drag. Compare: a 5-year loan leaves you paying for years after the need ends; shorter ones pivot you to savings or investments, like mutual funds yielding 12-15% annually.

For NRIs or gig workers remitting via UPI, it’s gold. Shorter cycles match repatriation timelines, avoiding forex risks. Psychologically, it shifts the mindset from debt dread to opportunity—more on that soon.

The Psychology of Debt: Why Short Wins Hearts and Wallets

Debt isn’t only about numbers; it messes with your feelings. Behavioural finance says that borrowers who take big risks tend to focus on what they want now instead of thinking about the future. Long tenures feed this, leading to over-borrowing. Shorter ones trigger “commitment devices,” like apps locking funds.

In India, where 70% lack financial literacy (per NFIF surveys), this matters. A Pune startup founder shared: “24 months felt daunting, but ticking off milestones built confidence.” Lenders leverage nudge theory—framing short terms as “quick wins” reduces dropouts.

Contrast with temptation: easy 60-month apps like LazyPay lure, but defaults spike. Short tenures build resilience, mirroring Diwali savings habits scaled up.

Global Lessons: Why India Leads in Smart Short-Term Lending

Peek abroad: US subprime crisis (2008) stemmed from 30-year high-risk mortgages—NPAs hit 10%. India dodged this via conservative tenures. UK’s Buy Now Pay Later (Klarna) caps at 6 months for risks, mirroring us.

Singapore’s high-risk MFI loans average 24 months, with 95% recovery. India excels: fintechs like Pine Labs report 85% on-time for short MSME terms vs. 65% long. RBI’s preemptive strikes (e.g., 2024 coin lending curbs) keep us ahead.

Real-World Examples from India’s Lending Scene

Let’s ground this in stories you’ll recognise. In 2023, Paytm faced RBI heat for lax lending; high-risk microloans defaulted at 8%. Post-crackdown, they shifted to 6-12-month tenures for sub-700 CIBIL scores. Defaults dropped 40%, per reports. Borrowers? Many stabilised, accessing larger sums later.

Consider fintechs like Kissht or MoneyTap. Their “pay later” for high-risk users caps at 9 months. Why? Data shows 70% completion rates vs. 50% for longer. A Kolkata homemaker borrowing for her boutique cleared ₹1.5 lakh in 12 months—now she’s pitching to Amazon sellers.

Traditional banks shine too. SBI’s MSME loans under CGTMSE often shorten to 36 months for new ventures. During Atmanirbhar Bharat, this saved thousands from over-leveraging amid lockdowns. HDFC’s 2025 data: short-term personal loans for gig workers yielded 15% lower delinquencies.

Even gold loans from Muthoot or Manappuram, which are high-risk (unverified income), get 12 months, not 36. It aligns with gold’s liquidity, letting you renew if needed without snowballing debt. A Hyderabad trader rolled over thrice, each short cycle boosting his score.

The Hidden Costs of Long Tenures for High-Risk Profiles

Flip the script: What if lenders only provided loans with a long duration to repay? Bad idea. Interest becomes compounded, causing a ₹5 lakh loan to generate ₹7.4 lakh in total when compounded at 15% for 5 years. Additionally, those high-risk borrowers who may encounter unanticipated challenges that could impact their ability to pay back their loans (e.g., vendors impacted by the increase in onion prices in 2023) typically miss their payment obligations and incur late fees (2-4% per month) and penalty fees (as dictated by the RBI limits) on top of that.

Credit scores tank further. One missed EMI drops CIBIL by 50-100 points, locking you out of housing or vehicle loans. Prepayment penalties (up to 4% on floating rates) trap you longer. Opportunity cost? Funds tied in debt miss stock rallies (Nifty up 20% in 2025).

Economically, it’s brutal. India’s informal sector (90% workforce) can’t handle 7-year drags. Shorter tenures mitigate inflation erosion—RBI targets 4%, but food inflation hits 8%. You repay with devalued rupees faster. Family ripple: kids’ education funds diverted.

Lenders hedge via higher rates too: 18-25% for high-risk vs. 10-12% prime. Shorter terms temper the total outflow.

Advanced Lender Strategies: Data, AI, and Beyond

How do they decide? Algorithms rule. Neo-banks like Jupiter use AI on 6 months’ statements, flagging volatility. Machine learning predicts defaults with 90% accuracy, auto-shortening tenures.

RBI’s playbook: 2019’s ECL norms force provisioning (15% for loss assets). Shorter exposure cuts this cost. Digital KYC and Aadhaar e-sign speed approvals but tighten tenures. Alternative data—UPI flows, GST returns—fine-tunes for MSMEs.

Co-lending (banks + fintechs) under 2021 guidelines pairs this—banks take long-term, low-risk, fintechs handle short, high-risk slices. 2026’s Account Aggregator framework supercharges: real-time data slashes risk mispricing.

Borrower Playbook: 5 Steps to Thrive with Short Tenures

You’re not powerless. 1: Audit capacity—use RBI’s DSR calculator; aim <40%. 2: Align with cycles (e.g., wedding season loans pre-Diwali). 3: Build buffers via RD accounts. 4: Negotiate flexi-options. 5: Track via the CIBIL app, pre-pay 10-20%.

Real win: Ahmedabad food vendor used a 12-month term to pivot to cloud kitchen, scaling 3x.

Regulatory Evolution: RBI’s Role in Shaping Smarter Lending

RBI’s journey: 2014’s internal ombudsman for complaints spurred caution. 2022’s digital lending guidelines capped tenures implicitly via risk weights. 2025’s P2P tweaks mandate short terms for high-risk peer loans. Future? AI ethics norms ensure fair shortening.

Schemes like Stand-Up India blend: 7 years max, but high-risk get monitored shorteners.

Future Trends: Fintech’s Short-Tenure Revolution

By 2027, embedded finance (loans in ONDC) will default to 12-24 months for risks, using blockchain for instant scoring. Voice loans via Google Pay? Short by design. Sustainable finance twist: green MSME loans shorten for quick impact measurement.

Wrapping Up: Shorter Tenures, Smarter Futures

In India’s lending maze, shorter tenures for high-risk borrowers aren’t hurdles—they’re guardrails. They tame risk, amplify repayment muscle, and cement stability, turning potential pitfalls into progress. From psych boosts to regulatory smarts, the case is ironclad. Lenders win with lower NPAs; you win with quicker freedom and better credit. Next time that 24-month offer lands, see it as a vote of calculated confidence.

Borrow wisely, repay fiercely, and watch your financial story rewrite itself.