Loans can be a necessary part of life. They allow you to make a big purchase or cover an unexpected cost. However, taking out a loan can seem intimidating if you aren’t informed of the steps to the process or the terms you need to comply with. Fortunately, you can easily educate yourself so you can make the best choice.
The more familiar you are with how a loan works, the more confident you can be when discussing terms with your lender. Here we discuss everything you need to know about one of the most popular types of loans, called the installment loan.
What Are Installment Loans?
An installment loan is a lump sum of money that a borrower receives from a lender. The amount is then paid back with a set number of payments or installments. Payments are usually made once per month and contain an amount that goes toward paying down the principal balance and the interest charge.
You cannot add funds to your loan later, so you must determine the amount you need to borrow up-front. The amount of your payment is usually fixed so that you will pay the same amount each time. The interest on your loan may be fixed-rate, or you could choose a variable interest rate that fluctuates. These types of loans can be repaid within a few months or have a repayment schedule that lasts for up to 30 years. Your lender sets the terms of your loan. You must thoroughly review all the loan documents before signing to signal your agreement.
Common Loan Uses
You have probably heard of some of the more typical uses of an installment loan. You may even have had one yourself. Mortgages, auto, personal, and student loans are all examples of installment loans.
The length of the loan can vary depending on what you are using the money for. For example, a mortgage generally has longer repayment terms than an auto loan. While opting for an extended payment schedule can result in lower monthly payments, it also means you could have a higher interest rate and will end up paying more over the life of the loan.
One of the most favorable aspects of an installment loan is predictability. Since you know the number of your loan payments, it’s easier to budget. You will also be aware of the date when you can fulfill the obligation by paying back your debt in full. This way, you can plan for other large purchases and make informed financial decisions.
Installment loans are a convenient way to finance large purchases like a house or car. You determine what you need and can afford in advance, so you only borrow what you can repay. In addition, the flexible loan terms and individualized solutions offered by many lenders make them an appealing choice.
All loans have potential drawbacks that you need to be aware of before committing yourself to the obligation. For example, when you apply for an installment loan, your lender will take a close look at your credit report. If you have made financial mistakes in the past, it may be difficult to qualify for a loan, or you might have to settle for subpar terms like high interest rates.
Installment loans can have additional fees beyond your monthly payment. Some lenders collect an origination fee when the loan is first processed or even require that you pay the penalty for paying the loan off early.
If you fail to pay your loan off as required, you could face collections activity, wage garnishment, and harm your credit. In addition, this would make it more difficult to obtain another loan in the future.
Types of Installment Loans
There are two types of installment loans that you can consider. The first type is a secured loan that requires collateral, an asset you use to guarantee that you will pay the debt. If you don’t meet the agreed-upon terms, you forfeit the asset, and it becomes the property of your lender. Your mortgage is an example of a secured loan where your house is the collateral.
The second type of loan is called unsecured, which does not require collateral. An unsecured loan usually has a higher interest rate. It’s based more strictly on your creditworthiness. Your credit score, history, and ability to repay the loan are examined before any credit is extended to you.
Why do secured installment loans have lower interest rates than non-secured loans?
Generally, secured installment loans are less risky than non-secured installment loans. The reason is that secured installment loans use assets as insurance while non-secured installment loans do not have the insurance of assets.
Since non-secured loans are non-insured, they are riskier for lenders and, therefore, carry a relatively higher interest rate than secured installment loans.
Are payday loans installment loans?
Payday loans do not typically fall within the category of installment loans. This is because lenders usually require people who take out payday loans to make one huge repayment on their next payday.
In some cases, however, lenders may provide borrowers with more flexible terms which allow them to make payday loan repayments in multiple installments.
If you decide that an installment loan is the right choice, you will need to complete the application process, which involves:
- Determine the needed loan amount
- Fill out the lender’s loan application completely
- Provide documentation to verify your identity and income
- Agree to have your credit history checked
- Wait for a decision
- Discuss loan terms with your lender
- Review and sign the loan documents
Plan to start your loan process as soon as you can. It takes time to go through all the steps, so you may need to wait a while before receiving the money you need.
It’s best to wait and apply for an installment loan after you have built up your credit and have good odds of approval with good loan terms. Your credit usage, score, and repayment history are examined to see if you are a good risk. If you have a low score, work on improving it before you apply for a loan if this is possible. If you have a low credit score or uneven repayment history, you could benefit from applying for your loan with a co-signer. This is another party that takes responsibility for paying back the loan if you fail to do so.
Your lender will likely require you to verify your employment and the income that you make. This gives them a good idea of your ability to pay back the loan and the amount they can extend to you in credit.
You will also need to prove your identity, residence, contact information, and an active checking account. Your chosen lender will review all of this information and consider the intended use of the loan to make their decision.
Affect on Credit
An installment loan can be an excellent way to build or improve your credit if you take care to make all your payments on time and meet the terms of the loan in full. However, late or missed payments can cause significant damage. Your credit score could drop, making access to future loans or other forms of credit a challenge until the derogatory reports fall off your report. In addition, it would be best to keep in mind that your debt to income ratio and credit usage will affect future applications. So, you may need to prepare yourself to pay off one loan before getting another.
Review your situation thoroughly before you begin the loan application process. Once you are clear on the amount of money you need and the payments you can afford, you can begin to discuss your options with a lender. Keep in mind that as your financial situation changes, your potential loan approval and terms may become more or less favorable. Therefore, stay informed about your finances, credit history, and needs so you can pursue a loan under the most favorable circumstances.