Chances are you’ve heard about that term several times from a friend, a loan expert or perhaps online or in the media.
But what exactly is an installment loan?
An installment loan is any type of consumer loan that mandates the borrower to pay back in due course based on a pre-agreed schedule.
Installment loans are often used to strengthen other debts, build credit or even finance the buying of costly things such as cars or houses.
To figure out how this loan could affect your finances, we assess the most popular types of installment loans and other similar products for people who are only interested in building credit.
Defining Installment Loans
An installment loan is a type of consumer debt that is paid back within a specified scheduled times.
Credit unions and banks are the most effective lenders who offer installment loans and these consist of mortgages, personal loans
Though car loans and mortgages are used to finance precise spending, personal loans can be used for several different purposes.
That include building credit, debt consolidation, and even funding daily living costs.
People with poor credit as well as low-income consumers can get personal loans easily because the loan is unsecured.
Pay back is only guaranteed only by the borrower’s promise to repay and such promise is not secured by an asset such as a real estate property or a car.
Installment Loans vs. Pay Day Loans
Sometimes, personal installment loans are mistaken for payday loans, which are short-term loans that borrowers pay back as one lump sum and not in several installments.
However, Payday loans consist of amounts of money that are lower than mortgages and car loans. Also, Payday loans interest rates are higher.
For instance, a standard two-week payday loan for $200 attracts a fee of $12 to $30 which sums up to an annual interest rate of about 390 percent to 780 percent.
These loans are often very important whenever a potential borrower needs
However, the high interest rates may have bad consequences for your financial status.
If you’re considering a Payday loan, you should review every other alternative available to find out if you can get a better deal.
What Are The Common Types Of Installment Loans?
The three most usual type of installment loans are:
- Car loans
- Personal loans
Car loans and mortgages often insist on good credit and in-depth vetting process prior to approval.
These loans are repaid in monthly installments that are scheduled over several years or even decades.
On the other hand, personal loans are easier to get than auto loans and mortgages mostly for low income borrowers.
However, personal loans have a higher interest rates.
Consumers use auto loans to finance the buying of a new car.
Similar to mortgages, auto loans are paid back in installment over a specified period of years.
Auto loan approvals are often approved based on good credit.
Also, auto loans and mortgages both require collateral and an upfront payment.
Loans that request collaterals, guarantees that a physical asset will be sacrificed to the lender if the consumer failed to repay the debt for whatever reason.
The most popular repayment plans for auto loans are often between 24 and 48 months.
However, other options such as 72 and 84 months are gradually becoming popular.
Although these longer loans attract lower monthly payments, consumers may end up paying much more over a period of 6 – 7 years more than the actual cost of the vehicle.
Interestingly, cars also depreciate in value over time, unlike real estate properties.
As such, a consumer can end up in debt by paying more for an older car than the actual worth of the car. This is known as “upside-down.”
Personal installment loans
This installment loans are mostly used by consumers who are interested in consolidating unsettled debt or provide a down payment for current credit card debt.
Personal loans can also be obtain to finance expenses such as vacations, birthday parties, and other similar discretionary costs.
Unlike Payday loans which are often required mostly during an emergency, personal loans can be used as a stepping stone to build long-term financial objectives such as building credit.
For instance, some consumers prefer to obtain personal installment loans rather than piling up credit card debt.
The installment plan and fixed interest rate of personal installment loans make them a more appealing type of credit than most typical credit card debt – which can escalate quickly if left unsettled.
However, for consumers with poor credit scores, their personal loans can attract interest rates up to 10 -25%.
Such interest rates may even be higher than some credit card rates.
Home mortgages are usually the most common type of long-term installment loans.
Mortgages are usually obtained in sums that are higher than $100,000 and are paid back with an agreed interest over a period of 15 – 30 years.
In nearly every case, borrowers who are interested in mortgages are required to make an upfront payment that covers from 3 – 20 percent of the entire loan amount.
Also, lenders will assess a potential borrower’s financial history and credit score to figure out the interest rate to be set on the mortgage.
Credit scores and installment loans
Credit scores not only affect your ability to obtain an installment loan, it also determines the rate of your installment loan.
Low credit scores are always a turn off when you’re applying for a larger or more expensive loans.
For instance, if you’re considering a mortgage, bear in mind that they have a stricter credit score conditions compared to an auto loan as real estate properties requires more larger loans than vehicles.
However, if you have a high credit score, your interest rates on 60-month loans for a new vehicle should be about 3%.
Similarly, consumers who have a fair credit may end up with credit pay rates of about 7 – 10 percent.
Also, consumers with poor credit may end up with a 15 percent rate or higher.
The variance of some few percentage points, mostly for longer loans, may cause paying thousands more on interest throughout the lifespan of a loan.
As a result of the long terms of mortgages, consumers with poor credits end up with interest rates that are lower compared to auto loans.
Nonetheless, paying interests for a home loan for several decades can result in payment of hundreds of thousands of dollars.
If you’re seeking for ways to boost your credit score, obtaining personal installment loans can be an easy and safe method of building credit.
Since instalment loans have fixed rates, they are a steady low-risk method for obtaining and repaying debt.