How Installment Loans Work: What You Should Know Before You Apply for One
The simplest definition of an installment loan is borrowing an agreed/set amount of money and paying the total amount borrowed through a series of MONTHLY PAYMENTS.
Still scratching your head? Don’t worry, here’s what you’ll learn in this guide:
- A complete definition of installment loans
- How they work
- Different types
- Advantages & disadvantages
- How to choose the loan properly
I’ve even listed a few lenders to help you get started! Ready to kick things off? Let’s go!
Installment Loans: Complete Definition
Simply put, installment loans are financial products.
You borrow a fixed amount of money that must be paid back over time through regularly scheduled payments.
You’re probably wondering, “How long will I pay for the loan?”
You and your lender set a fixed period of time to pay for the loan. This could range from 12 to 96 months. However, 96 months is a rare case.
The main factors that determine the amount of your regularly scheduled loan payments include the following:
- The loan amount
- The interest rate you’re charged
- The loan term or length of the loan.
One benefit is the amount of your regular scheduled payments, typically monthly payments, stay the same throughout the loan term.
This makes budgeting in advance easy for the borrower!
How is that possible?
It’s because installment loans typically come with fixed interest rates and fixed monthly payments!
Take Note: The longer your fixed period of time is, the higher your TOTAL amount will be. You pay a lot more with an 80-month loan than a 36-month loan.
The Advantages and Disadvantages of an Installment Loan
Before you consider getting an installment loan, it’s worth noting the advantages and disadvantages.
Better Credit limits than credit cards. Credit cards are much more flexible than installment loans, but when it comes to LARGE purchases, getting a loan can be a better option. In short, borrowing money for a loan is higher than the amount you can borrow from credit cards.
Predictable; better budgeting. Because of a fixed interest rate and a fixed monthly payment, it’s easier to budget and “predict” when your payments end. This way, you know when your debt ends and can plan your spending more effectively.
Not as flexible. If you need additional funds later on, it’s going to be much harder while you’re still strapped to your current loan.
Fixed interest rate. An installment loan lets you pay a fixed rate for better budget planning. However, this also means if the market condition changes, your rates won’t decrease.
Long-term commitment. Another disadvantage is the risk the borrower faces while locked into a long-term financial obligation. There’s a chance that unfortunate circumstances make borrowers unable to meet the scheduled payments.
Potentially higher rates. Yes – it’s possible to qualify for this loan even with poor credit. But it may also mean higher rates – up to 36%! Whereas those with good credit get lower rates. Paired with high loan fees, you lose much more.
Should You Apply for an Installment Loan?
The advantages and disadvantages are not to say these loans are harmful. You CAN apply but, ULTIMATELY take note of these three things:
- Your current financial stability – Assess your financial situation for better planning
- Your credit score – Expect higher rates for a lower credit score
- The loan amount you borrow – Don’t borrow more than what you can’t committedly pay for
Note: Missed payments can also lead to a higher risk.
Types of Installment Loans
I’ll take you through some things you need to differentiate when it comes to installment loans.
The Difference Between Secured and Unsecured Installment Loans
Loans can be either secured or unsecured. Let’s cover how these two types of installment loans differ:
A Secured Installment Loan Is Collateralized
Collateral refers to an asset the lender accepts as security for the loan. The collateral can be real estate or other assets. It depends on the purpose of the loan.
The collateral acts as protection for the lender. If the borrower defaults on their loan payments, the lender can seize the collateral and sell it to recover its losses.
An Unsecured Loan Is Non-Collateralized
These loans not requiring collateral are extended based on a borrower’s creditworthiness.
It’s usually indicated through a credit score and based on the borrower’s ability to repay (indicated by the borrower’s income and assets).
Unsecured loans usually have higher interest rates compared to a secured loan. This reflects the higher risk of non-repayment the lender accepts.
Common Types of Installment Loans
1.) Auto Loans
An auto loan is a secured loan.
Based on its name, it’s easy to tell what its purpose is. It’s used to buy a car (with the said car serving as collateral). It’s paid monthly normally over a term of 2 to 7 years.
2.) Mortgage Loans
A mortgage loan is a secured loan. Its single purpose is to buy property, normally a house.
The purchased house serves as collateral and the loan is paid monthly over a long term – normally 15 or 30 years.
3.) Student Loans
A student loan, also known as an education loan, has a purpose that’s easy to guess. It’s a sum of money borrowed to finance post-secondary education or higher education-related expenses.
It’s meant to cover the costs of tuition, books and supplies, and living expenses during the borrower’s pursuit of a degree. The payments are usually deferred during the borrower’s time in college.
Sometimes the payments are even deferred for an additional “grace period” (a six-month period after earning a degree). That depends on the lender though.
4.) Personal Loans
A personal loan is a lump-sum loan and is normally repaid in 2 to 5 years. It’s normally unsecured and the money from a personal loan can be used for the following:
- Used to consolidate debt
- Fund your home improvement project
- Pay for a wedding
- Cover emergency expenses like medical bills
The Process of Applying for an Installment Loan
Now I’ll talk about some steps a borrower has to go through to apply for an installment loan. Let’s look at them one by one.
First, a borrower fills out an application with a lender. The application normally specifies the purpose of the loan (i.e. for buying a car).
The lender and borrower discuss options. This discussion covers stuff such as the down payment, the loan’s term, the payment schedule, and the payment amounts. Here’s an example just to give a clearer picture…
Imagine you want to borrow a certain amount to finance a planned car purchase. The lender informs you making a higher down payment could get you a lower interest rate. Even the option of obtaining lower monthly payments by going for a longer-term loan could be brought up.
After the discussion, the lender reviews your creditworthiness. This is to determine the amount of credit and the loan terms the lender is willing to offer you.
You can usually retire the loan by making the required scheduled payments. You can also save yourself from interest charges by paying off the loan early.
How Do You Choose an Installment Loan?
When choosing among installment loans, there are multiple things to consider . Here are some tidbits to help you out.
1.) Compare Annual Percentage Rates
Annual percentage rate is how the cost of an installment loan is normally indicated. It includes the interest rate PLUS any fees.
Pro Tip: Go for the lowest APR you can find. Personal loans that are most consumer-friendly have rates below 36%. Then again, your credit score contributes to “how healthy” (lower of higher) these rates are.
Helpful Pointers: How to Find the Best Installment Loan Rates
It greatly depends on your credit and finances. You also have to know what to look for. Here are some tips to find installment loans with the best rates:
- Review your credit report! Make sure there are no errors. Discrepancies, like a late payment in your payment history, could affect your credit score.
- Establish habits to maintain a good credit score! Are you working on building good credit? Make sure you’re making on-time payments and keeping your debt-to-income ratio low! Also take note, borrowers typically have several years of credit history with a variety of accounts.
- Knowing the eligibility requirements helps! Your credit score is one of the most important factors for eligibility. Keep in mind, lenders may also look at your income and debt-to-income ratio though. Find lenders that don’t put much weight on credit scores if you have bad credit.
- Repayment terms are important! They’re normally 2 to 5 years for personal loans, some are as long as 10 years. Shorter terms decrease the overall interest you’ll pay, but increase your monthly payments. Whereas longer terms decrease your monthly payment dues BUT increase the total amount you pay.
2.) Learn About Fees
Make sure the lender discloses all fees before you agree to borrow money!
Some lenders charge origination fees (usually 1% to 10% of the loan amount) or late fees.
3.) Calculate Monthly Installments
The longer the term of your installment loan, the more you’ll pay in interest. You can calculate your monthly payments based on your chosen term length.
Pro Tip: Find a repayment term short enough to make your payments manageable and avoid overpaying on interest.
Pre-qualifying is a simple way to find out if you qualify for an installment loan.
You’ll fill out an application with information regarding your income and your desired loan during this procedure.
The lender will do a soft credit inquiry. Afterwhich, you’ll see what loan rates, terms, and loan amounts you may qualify for. Don’t worry! Your credit score won’t be affected.
How Do You Get an Installment Loan if You Have Bad Credit?
There are options available for this type of situation.
In fact, it’s even possible to get an installment loan with no credit check. Some lenders offer long-term installment loans without a hard inquiry on your credit report.
It doesn’t necessarily mean it’s a good idea to borrow money from them though.
They can’t measure your creditworthiness or ability to repay without a credit check.
If they can’t access your credit reports and credit scores, they’re going to find a way to somehow alleviate their risk. It could be through lower loan amounts and very high-interest rates.
Make sure to do your research and compare possible choices first. You should expect your options to have higher rates and possibly more loan fees.
It’s not that you should choose what you can save more on. What matters is the accuracy & credibility of the whole process.
You’ll likely find higher loan amounts, longer repayment terms, and ACCURATE rates if you have your credit checked with a mainstream lender.
Where to Get Some of the Best Installment Loans
I listed down a few lenders you could look at to help you get a feel of going through the process of choosing the right installment loan for you.
Some of them even offer the best options depending on your needs!
LendingClub is a peer-to-peer lender. This means you receive your funds from individual investors, not a traditional bank.
- You can borrow money for nearly any reason (debt consolidation, home improvement projects)
- It’s easy to get prequalified online (no hard inquiry on your credit report)
- Their installment loans come with an origination fee of 3% to 6% of your loan amount
Upstart is an online installment loan lender. They offer online installment loans to borrowers with good or even fair credit.
- You can apply for your installment loan online and receive your funds as soon as the next business day
- When approving you for a personal loan, they also consider your education and job history (not only your credit score)
- Their interest rates can be high for consumers with substandard credit (up to 35.99% APR)
- Their origination fees can be as high as 8% of your loan amount
3.) OneMain Financial
OneMain Financial is an online lender that offers secured or co-signed personal loans to borrowers with bad credit. They even offer online educational resources to help possible borrowers.
- You have the option to choose a payment date
- They’re able to fund a personal loan the same or next business day
- They charge an origination fee and have high rates (18% to 35.99% APR) compared to other online lenders
- They don’t offer direct payment to creditors on debt consolidation loans
FAQs: Follow-Ups About Installment Loans
In this section are answers to some commonly asked follow-ups. If you’ve got some more questions, hopefully this covers it.
Is Having Multiple Installment Loans Possible?
Yes. It’s not only possible, but it’s also common. Paying a mortgage and making car payments is an example of having two installment loans.
What Are the Differences Between Installment Loans and Payday Loans?
Payday loans are secured by your paycheck. You give the lender a postdated check to deposit on your next payday or give the lender authorization to withdraw the money from your bank account when you get paid.
Be careful when getting a payday loan though. Lenders charge very high fees and can send you into a cycle of mounting debt.
How Does Getting an Installment Loan for Debt Consolidation Work?
It’s possible to use installment loans for debt consolidation since they normally offer lower interest rates than credit cards.
Let’s say you have credit card debt from multiple lines at 15% APR.
Transferring that existing debt to an installment at 6% APR can save you money. You pay less in interest and can devote your attention to paying one fixed bill as a result.
What if I End Up Defaulting on My Installment Loan?
The simple answer is your credit score takes a hit. Lenders see you as being riskier when your credit score is low.
This will make qualifying for better rates and terms on future loans more difficult, it’s even possible to not qualify at all. If you acquired a secured loan, the lender may seize the collateral you provided.
Wrapping It Up
To cap this article off, let me summarize it into a few points:
- Getting a loan you pay through scheduled payments has its advantages and disadvantages. Properly weigh them before making a choice.
- An installment loan has different types. It can be a personal loan, a mortgage loan, an auto loan, or a student loan. Each one is designed to meet a specific need. Know which one to choose.
- Practice due diligence! Some lenders might offer you terms that put you at a disadvantage and get you deeper into debt. Being as informed as possible will help you a lot!
- It’s also possible to get a loan even with poor credit. Just be careful!
That’s pretty much it! I hope I helped you out. If you have any questions, have a go in the comments section! I’ll gladly answer them!