An installment loan is a type of loan where the borrower repays the loan in fixed payments over a set period of time. The purpose of an installment loan is to provide borrowers with the necessary funds for a large purchase or to consolidate debt.
This article will explain how installment loans work, the different types available, and the pros and cons of using them.
How an Installment Loan Works
The Loan Application Process
Borrowers typically apply for an installment loan by submitting a loan application to a lender, which may be a bank, credit union, or online lender. The application will typically require personal and financial information, such as income, employment history, and credit scores.
The lender will use this information to determine the borrower’s creditworthiness and the terms of the loan, such as the interest rate and repayment schedule. Once the loan is approved, the borrower will typically be required to sign a loan agreement outlining the terms of the loan.
Interest Rates and Fees
The interest rate on an installment loan is the cost of borrowing the money, and is typically a percentage of the loan amount. Interest rates can vary greatly depending on the type of loan, the lender, and the borrower’s credit history.
Some lenders may also charge origination fees, application fees, or other types of fees. This should be taken into consideration when comparing loan offers.
Repayment Terms
The repayment terms of an installment loan will vary depending on the type of loan and the lender. Typically, installment loans have fixed repayment schedules, with equal monthly payments over a set period of time.
The repayment period can range from a few months to several years, depending on the loan amount and the borrower’s ability to repay. Borrowers should understand loan repayment terms and only borrow what they can afford to repay.
Types of Installment Loans
Let’s discuss the different types of installment loans available to borrowers. These include personal loans, mortgage loans, auto loans, and student loans. Each type of loan serves a specific purpose and has its own unique terms and conditions.
Personal Loans
A personal loan is an unsecured loan that can be used for a variety of purposes such as debt consolidation, home improvement, or unexpected expenses. They are typically offered by banks, credit unions, and online lenders.
Personal loans are often considered a flexible option since they typically don’t require any collateral and the funds can be used for any purpose. However, personal loans often have higher interest rates compared to other types of installment loans.
Mortgage Loans
Mortgage loans are secured loans used to purchase a home or refinance an existing mortgage. They require collateral in the form of the property being purchased or refinanced.
The interest rates for mortgage loans are usually lower than unsecured personal loans. They are available from banks, credit unions, and mortgage companies.
Auto Loans
An auto loan is a secured loan used to purchase a vehicle. They require collateral in the form of the vehicle being purchased.
Like mortgage loans, auto loans often have lower interest rates than unsecured personal loans. They are available from banks, credit unions, and auto dealerships.
Student Loans
Student loans are designed to help students pay for education-related expenses such as tuition, books, and living expenses. They can be unsecured or secured loans and the interest rate varies depending on the type of loan and the lender. They are available from the government, banks, and other financial institutions.
Pros and Cons of Installment Loans
Pros
- Predictable monthly payments: One of the main advantages of installment loans is that they have fixed repayment schedules, which means the monthly payments are predictable and budget-friendly. Borrowers can plan their finances accordingly.
- Opportunity to build your credit history: Repaying an installment loan on time can improve a borrower’s credit scores, which can make it easier to qualify for future loans or credit cards.
- Ability to purchase larger items: Installment loans allow borrowers to make larger purchases, such as a car or a home, that they may not be able to afford with cash or credit cards.
Cons
- High interest rates: One of the main disadvantages of installment loans is that they often have higher interest rates compared to other types of loans. This can make the total cost of borrowing pricier over time.
- Risk of default: If a borrower is unable to make payments on time, they risk defaulting on the loan and damaging their credit scores. This can also result in additional fees or penalties.
- Limited flexibility: Installment loans typically have fixed repayment schedules, which means that the borrower must make a set payment every month. This can make it difficult to make adjustments if the borrower’s financial situation changes.
How to Get an Installment Loan
The best place to always start shopping around for an installment loan is your local bank or credit union. If you already have a history with them, they’ll be much likelier to give you a good interest rate. So start there.
Once you’re given numbers, take your search elsewhere and compare your offers. Online lenders are a dime a dozen these days, and some are more trustworthy than others. By no means are a lot of them shady, but definitely do your research and read the online reviews.
Keep in mind that a lot of lenders have bad reviews from past customers; generally, ones who have had collections sent after them when they didn’t pay their bills.
People are never more inclined to leave a review than when they feel they’ve been jilted. So, read the reviews, but discard the ones where people are clearly just angry because they couldn’t put off payments indefinitely.
See also: Top 3 Loans for Bad Credit with Monthly Payments
Installment Loan FAQs
What is the highest amount you can get?
It depends on how strong you are financially. If you make a lot of money, have solid credit, and don’t have a lot of debt, you should be able to take a fairly large installment loan.
That said, many states have restrictions on the maximum amount you can take out, and it will also depend on the lender. Speedy Cash, for example, has a maximum online loan amount of $750 for people who live in Virginia.
A word of caution, however: just because you’re approved for a certain amount doesn’t mean you should take out the maximum amount. Be sure to only ever take out what you need and can affordably pay back.
Do installment loans require credit checks?
Most lenders do check your credit history, so if you’re in a situation where you know you’re going to need a loan, it pays to check your credit score. Often times your bank or credit card will give you your FICO score for free. If they don’t, you can go to myFICO.
You can get all three credit bureau reports and FICO scores for $60, or you can get one for $20. TransUnion, Experian, and Equifax may vary depending on which ones your creditors report to. One may have an error or negative mark that the others won’t. This is why you should look at your credit report at the same time.
Your credit reports are a complete account of your financial history — meaning on-time payments, missed payments, defaults, and bankruptcies. You definitely need to keep track of your credit reports!
A 2013 Federal Trade Commission study found that over 42 million Americans had errors on their credit reports. Avoid this by getting your free reports once a year through Annual Credit Report. If you see an error, take action and report the error to the credit bureau immediately.
If you know you have bad credit and will need cash before you’ll be able to improve it, there are installment loans specifically for bad credit borrowers.
There are cons to taking out these types of loans (including collateral and high interest rates.) So, do your research first and make sure you won’t qualify for a normal installment loan.
Do I have a certain purpose for taking out a loan?
It depends on the type of loan you get. Car loans, home mortgages, or student loans obviously all require you to use the money for a set purchase or investment. But if you just get a general unsecured personal loan, in most cases, you can use the money for anything you need or want, no questions asked.
People often use unsecured loans for surprise purchases, such as car maintenance or hospital visits. In essence, they’re often used for things that, in a better economy, people would have the money to pay for out-of-pocket without it tipping the scales as much.
Do all installment loans have fixed interest rates?
Unfortunately, not all of them do, but many do. Most lenders know that borrowers prefer installment loans with fixed interest rates over ones with variable ones because it allows them to truly budget and plan their expenses each month and year.
Before taking out an installment loan, be sure to ask the lender which types they offer. They may offer both.
Installment loans with variable interest rates will often start at a lower rate than fixed loans. But they usually rise enough over the course of the loan that they almost equal fixed loans by the time they’re paid off.
That’s not always the case, and many times borrowers will end up paying more than if they had gone with the fixed loan from the very beginning. It’s definitely not fun being surprised a few months in and seeing that your monthly payments have risen.
What requirements are needed for a loan application?
While specific qualifications are likely to vary based on the lender, you can count on some similar guidelines like these:
- You have to live in the state where you take out the loan.
- You have to be at least 18 years old.
- Most require a valid checking or savings account.
- You can’t be a debtor in bankruptcy or about to file for bankruptcy.
- Most require a copy of your government-issued I.D.
- You don’t have to be employed, but you do have to have a steady source of income.
- You must have a valid security number or taxpayer identification number.
How fast can I get the money once approved?
Not to sound like a broken record, but it depends on the lender. Some online lenders are able to deposit the cash instantly into your checking account. Whereas others need one to two business days, if not a little longer.
A word of caution: the faster you get the money, the higher the rates usually are. It’s not written in stone, but is a good rule of thumb.
Can I pay off the loan early?
Some lenders allow borrowers to pay off installment loans early, and some do not. After all, the way they make their money is through interest. The lenders that do allow you to pay off early will typically charge fees to compensate for the loss of money they’d get through interest. Depending on the lender, it may not even be worth it.
On the opposite end, some creditors don’t care if you pay off early and won’t find you at all. If you foresee possibly being able to pay off your installment early, check to see if there will be any fees first.
How do installment loans affect your credit score?
Installment loans can have a positive or negative impact on your credit score, depending on how you handle the loan.
If you make your payments on time, the loan will be reported to the credit bureaus and can help to improve your credit score. A positive payment history is a major factor in determining your credit score.
On the other hand, if you miss payments or default on the loan, it will be reported to the credit bureaus and can negatively impact your credit score. Late or missed payments can lower your credit score, and a default or foreclosure can cause a significant drop in your credit score.
Additionally, the credit bureaus also factor in other things such as the type of credit you have, how long you have had credit, and how much credit you are using. So, having a mix of credit types, such as an installment loan, credit card, and mortgage, can be beneficial for your credit score.
What is the difference between an installment loan and a payday loan?
Both types of loans are known for getting borrowers cash very fast. And that makes them great for when you have an emergency. However, there are differences between the two — mainly revolving around the length of the loan (or repayment period) and any fees that may occur.
With payday loans, you typically owe the entire amount back (plus any fees) by the time of your next paycheck. That’s why they’re called “payday” loans. Installment loans are different in that they accrue interest on a daily basis. You also have a longer time repayment period to pay the entire amount back.
