Hefty purchases, payments over time, low-interest rates — an installment loan sounds like the end-all to your financial woes. The question is: is it the best loan choice for you?
Every loan comes with a price. Some lenders offer risky loans that can send your finances into a neverending tailspin. Other loans may provide much-needed funds, but can damage your credit score.
It literally pays to do your homework on which type of loan is best for your unique needs. When used correctly, an installment loan can be one of the best financial decisions you’ll make. Here’s what you need to know:
What is an Installment Loan?
In simple terms, an installment loan is a type of loan that requires scheduled payments over time. These payments are called installments.
Unlike payday loans, installment loans give you more time to pay off your debt. Typically, you need to make at least two payments for it to qualify as an installment loan. These loans also enable you to make smaller payments rather than a lump sum repayment.
Types of Installment Loans
While you may not be familiar with the term, you’ve probably used installment loans before. Mortgages, student loans, and car loans all fall under this category.
Credit cards are a form of installment loan. You make open-ended purchases with the promise you will make a minimum payment towards those purchases each month. However, credit cards often carry a much higher interest rate than traditional installment loans.
Installment loans come in all sizes and amounts, depending on what you’re using the money for.
One of the biggest advantages of this type of loan is that they offer fixed interest rates. Some traditional methods of borrowing have varying interest rates that can make it difficult to gauge how much they’re really paying.
In many cases, borrowers end up paying more than they anticipated with varying interest. If payments increase because of rising interest rates, the borrower may delay making payments. This triggers a serious set of negative consequences, such as sinking credit scores or falling behind in payments.
By offering loans with fixed interest rates, lenders are giving borrowers a chance to better plan for their loan payments and ensure they’re capable of meeting the requirements.
As a result, it puts borrowers’ minds at ease, which makes them feel better about having to borrow in the first place. This peace of mind might also make it more attractive for them to borrow more in the future.
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Seven Reasons to Choose an Installment Loan
As many problems as installment loans solve, they aren’t right for every situation. Here are seven situations when you may want to consider using this type of loan:
You Need to Make a Large Purchase
Large purchases can be hard to come by unless you’ve got a lot of cash stashed away or you take out a loan.
The majority of people are unable to purchase cars and homes outright, which is why they choose an installment loan. Though loan terms, amounts, and interest rates vary, all installment loans are generally used for large purchases.
Installment Loans Exist for Just About Everything
One of the best things about installment loans is the versatility. You can get an installment loan for nearly every large purchase.
The obvious installment loans are home mortgages and auto loans. But think about the last time you bought furniture for your home: did you shell out thousands of dollars to outfit your living room, or did you make payments to the furniture store over time?
Jewelry, home repairs, medical bills, auto repairs, and school tuition are all good reasons to take out an installment loan. Some people use them to pay off their high-interest credit cards and lower their debt.
You Have Good Credit
Typically, people who have good credit receive better interest rates than those with bad credit. This means you stand a better chance of securing the funds you need for a less severe repayment price.
In addition, other types of loans may be easy to acquire but could damage your credit score in the process. If you have good credit, you obviously worked hard for it. You wouldn’t want to risk it by taking out the wrong type of loan.
One of the benefits of taking out an installment loan if you already have good credit is that you get to continue building your credit. Every time you make a payment, your credit score wins.
You Want to Build Credit
Most folks think that you have to have credit before you can get an installment. That’s simply not true.
Loans are one of the simplest ways to build credit or fix bad credit. There are bad credit installment loans tailored for those large, unexpected expenses, like car repairs or medical emergencies.
With every payment made on time, your credit score gets a boost. It’s a redemption for many who have bad credit.
As a result, your good credit you build through an installment loan can open future opportunities for better loans. It signals to lenders that you’re not likely to default on your own lest you risk a drop in your hard-earned credit score.
You Don’t Have a Job
Another myth surrounding installment loans is that you need proof of a job to acquire the loan. Again, this is a false statement.
As long as you have some form of recurring income, you can qualify for an installment loan. Things like social security payments, pension, or other income would count as income.
You will need to provide proof of your income. Lenders want to know you have the means to repay the loan, but don’t necessarily require a specific source of income.
Lenders Do Not Always Require Collateral
Installment loans come in multiple forms, including personal loans and loans for specific purchases, like a car or house. Some loans will require collateral as an extra assurance you’ll repay the loan. Other loans require no collateral.
When you take out an auto loan, you’re putting up your financed vehicle as collateral. Essentially, your lender has paid the dealership for the car, and you are repaying the lender. If you default on your payments, the lender has the right to sell the car to recoup the remaining balance.
This type of loan is a secured loan. This means that in the event the lender doesn’t receive payment, they have collateral to make up the difference.
Other loans, like personal loans, do not require collateral. These are referred to as unsecured loans. Instead, the lender may rely on things like credit score and income sources to determine your reliability in repaying the borrowed amount.
Because of this potential, installment loans are often sought by those who have no collateral bargaining chips.
Unexpected Situations Won’t Devastate Your Finances
Emergency surgery, car malfunctions, busted hot water heater – these things are never planned for and can wreak havoc on savings accounts. Given that nearly half of Americans are living paycheck to paycheck, one disaster can have lasting negative impact on your finances.
Installment loans can help you pay for these surprise expenses without crippling your finances. A $100 a month payment for a few years is much more manageable than a $5,000 hospital bill due at once.
If you found yourself in an expensive situation, you likely didn’t have a choice. An emergency surgery could have been a life or death matter. You need a working car to get to your job that produces income.
Think of the consequences of opting out of these expenses. For example, if you didn’t get your car repaired, you may risk losing your job if you can’t make it work. No job means no money to get your car working again.
Relying on loans paid in small amounts over time helps you take care of business so life can keep going. No one likes having expensive catastrophes disrupt their finances. An installment loan can remove some of the financial burden, despite the fact you have to repay it with interest.
What To Look For in an Installment Loan
An installment loan may be able to get you the money you need, but that shouldn’t be the deciding vote on whether to take it.
Calculating the True Cost
The term of the loan refers to the amount of time you have to repay the loan plus interest in full. It’s important to look at the loan term to decide if you can feasibly afford the loan.
For example, the term for many mortgages is 30 years. If you buy a $100,000 house and get an interest rate of 5%, your payments would equal around $694.44 per month.
This might seem more palatable to homeowners, as opposed to shelling out $100,000 at once for a home.
However, when you multiply the monthly payment over 12 months for 30 years (the loan term), you realize you’re paying a grand total of around $250,000 for the home that only cost $100,000.
It sounds like a lot, but consider that you may never save $100,000 at once to afford a home outright. This is why installment loans make practical solutions for large purchases that may otherwise never be possible.
There are several factors that can influence interest rates, including your credit score and the government.
In general, the higher your credit score, the more competitive interest rate you may receive. People with lower credit scores may still acquire a loan, but it will come at a higher price.
Before taking out a loan, you should calculate what your payments will be including interest to see if you truly can afford it.
If you aren’t satisfied with your interest rate, a co-signor may be able to help you get a lower rate. This would require your co-signor to attach their name to your loan. If you do not keep up with payments, the co-signor would be a responsible party for repayment.
Installment loans are a win-win situation for both the borrower and the lender. The borrower gets to procure whatever they’re using the funds for, be it a car, house, or getting out of other debt. The lender gets all their money back, plus make money from the interest.
Lenders don’t profit unless they’re charging interest. This is why many lenders charge fees if you repay your loan in full before your term ends.
It’s in your best interest to repay your loan as quickly as possible. With each payment you make, you’re also paying interest on that money.
Let’s say you bought a new car for $35,000, and were offered either a five-year or six-year term with a 3% interest rate. Your payments for the five-year loan would equal around $671, while the six-year loan would need payments of about $574.
While the lower monthly payments seem attractive, you’re actually paying an extra $1,050 on the car in interest alone.
However, not all lenders will allow you pay off your loan quickly without it costing you. These charges are prepayment penalties.
The good news is that these penalties aren’t nearly as common as they were in the past. But they do still exist.
Before you ink the loan deal, ask your lender if there are any prepayment fees for paying off your loan early. You’ll be expected to follow the terms of your loan agreement, whether you knew about them or not.
Make sure you can make amortized payments on your loan. Amortized means your monthly payment goes to both the interest and the principal (original loan amount).
If all your payments go to the interest, you could theoretically be trapped in your loan forever. Your lender should be able to provide you with an amortization schedule to show how your payments are distributed between interest and principal each month.
Installment loans are saving grace for a variety of situations, especially when you can’t go without the thing that created the need for the loan.
Just remember that not all loans and lenders are created equal. You can’t afford to partner with a lender who doesn’t prioritize your finances first. A little research can be the best financial investment you’ll ever make.
Check out our blog for more ways to start affording the life you deserve.