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
When you take out an installment loan, you borrow a set amount of money and agree to repay it over time through fixed monthly payments. These payments cover both the loan balance and interest.
The Loan Application Process
To apply, you submit a loan application to a bank, credit union, or online lender. You’ll need to provide details like your income, employment history, and credit score. The lender reviews this information to decide if you qualify and what terms to offer. If approved, you’ll sign a loan agreement that lays out the interest rate, repayment schedule, and any fees.
Interest Rates And Fees
The interest rate is the cost of borrowing and is usually shown as a percentage of the loan amount. Rates can vary based on the type of loan, the lender, and your credit profile. Some lenders may also charge origination or application fees. Always factor in these costs when comparing loan offers.
Repayment Terms
Installment loans usually come with a fixed repayment schedule. You’ll make the same payment each month until the loan is paid off. Loan terms can range from a few months to several years, depending on how much you borrow and what you can afford.
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 various 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 & Cons of Installment Loans
Installment loans can be a helpful financial tool, but they also come with risks. Here are some of the main benefits and drawbacks to consider before applying.
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 many 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
Frequently Asked Questions
Do installment loans require credit checks?
Most lenders check your credit history. Your bank or credit card may offer free access to your FICO score. If not, you can buy it from myFICO.
Review all three credit reports—TransUnion, Experian, and Equifax—since errors may appear on only one. Federal law lets you get free reports yearly at Annual Credit Report. Correct any errors right away.
If your credit is poor, some lenders offer installment loans for bad credit borrowers. These often have higher rates or may require collateral.
Do I need a specific purpose for the loan?
Some loans, like car, mortgage, or student loans, must be used for a set purpose. Unsecured personal loans usually let you spend the funds however you choose, such as car repairs or medical bills.
Do all installment loans have fixed interest rates?
Many do, but some have variable rates. Variable rates may start lower but can increase over time, sometimes costing more than a fixed-rate loan.
Ask lenders what rate options they offer before borrowing.
What requirements are needed for a loan application?
While details vary, you generally need to:
- Live in the state where the loan is issued
- Be at least 18 years old
- Have a valid checking or savings account
- Not be in bankruptcy
- Provide a government-issued ID
- Show proof of steady income
- Have a valid Social Security number or taxpayer ID
How fast can I get the money once approved?
Some online lenders fund loans instantly. Others may take one to two business days. Faster funding often comes with higher rates.
Can I pay off the loan early?
Some lenders allow early payoff without penalties. Others may charge fees to recover lost interest. Always check for prepayment penalties before signing.
How do installment loans affect your credit score?
Paying on time can improve your credit score by building a positive payment history. Late or missed payments can lower your score and lead to fees or default.
Having a mix of credit types—installment loans, credit cards, and mortgages—can also help your credit profile.
What is the difference between an installment loan and a payday loan?
Payday loans require full repayment, plus fees, by your next paycheck. Installment loans have longer repayment terms and accrue interest daily. While both offer quick access to cash, installment loans give you more time to repay.
