There are many different types of loans to choose from and an installment loan is just one of them. This type of loan is designed so that the borrower pays back the money over a period of time and pays a predetermined payment each time. In most cases, these payments, or installments, are made on a monthly basis. The loan is granted and then interest is figured in before the payments begin. This way the loan is paid back in smaller payments over a set period of time.
How does an installment loan differ from a payday or other short-term loan?
Both payday loans and installment loans are sometimes considered to be “high-cost” loans because they carry higher interest rates than other types of loans. On reason for this is that many times borrowers either have very little income or have less than perfect credit scores. There are some basic differences between payday (short-term) loans and installment loans.
Typical Payday Loan
- Loans are usually between $100 and $1500
- Borrowers have a short time to pay back the loan- usually within 30 days
- Loans are usually paid by leaving a post-dated check or by automatic withdrawal on the due date
- Lenders charge a fee for loaning the money
- Loans are usually unsecured
- Loans can be rolled over if it can’t be paid off when it is due
Typical Installment Loan
- Loans usually range from $150 to thousands of dollars
- Principal, interest and any other fees are paid back in fixed monthly payments
- Loans can be renewed occasionally, usually every few months which results in higher amounts that need to be paid off
- Loans are usually secured by personal property (but not real estate property). Collateral might include a vehicle, power tools, jewelry, consumer electronics, or firearms
How does an installment loan differ from credit card debt?
Installment loans are much different than credit card debts. In many ways they are even better than credit cards. Here are some of the primary ways these two differ.
Credit Card Truths
- Very high interest rates
- Depend largely on your credit score and rating
- Some have annual membership dues
- Some cards are not issued without you putting up some cash up front
- Can take literally years to pay off (especially if you only pay the minimum due)
Benefits of Installment loans over Credit Cards
- The rate will not change for the duration of the loan
- The balance has to be paid off before another loan can be taken out
- Cash is directly deposited into your account
- Installment loans are easier to qualify for
- The payoff cycle is purposefully limited so that it is paid off in full in a shorter amount of time
- Payments do not change with the balance
Can an Installment Loan Help Improve my Credit Score?
In most cases, an installment loan is going to help boost your credit score. However, it’s not really worth it to take out an installment loan just for the purpose of improving your credit score. Your score depends on a few factors like your payment history, types of credit you use, lines of new credit, and length of your credit history. Before you decide to take out an installment loan think about these factors:
- Is the loan really necessary? If you need the cash for something big you can’t afford to pay all at once like a major appliance or a vehicle then it is a good deal and can help boost your credit score if you keep it as small as possible and make your payments on time.
- Is it cheaper than the other types of credit you owe? In other words, if the interest rates are lower than credit card debt or other debts, it can be a good idea to take out an installment loan to pay them off or consolidate them. You may save money over time and help improve your credit rating.
Are there any distinct advantages to installment loans?
Any time you use credit to buy a car, buy a house or pay college tuition you are likely agreeing to the terms of an installment loan. This means that you will be making regular payments for a predetermined amount of time until the initial loan amount, interest and any fees are paid off in full. There are some very distinct advantages to taking out a loan that you have to repay in installments rather than in a single payment.
- Installment loans typically require smaller monthly payments than other types of loans. This can make it much easier to work the payment into your monthly budget.
- Because of the way you are going to pay back an installment loan, you can borrow more money than if you use a short-term loan. Short-term loan amounts depend largely on how much you are going to get on your next paycheck. You can determine the amount of time you want to take to pay the loan back based on what type of payment you can make each month.
- There may be a tax break on the interest you pay on an installment loan. Usually it is school loans or mortgages for first time home buyers. Talk to tax accountant to determine if you are eligible for any such deductions.
Are there any disadvantages to taking out an installment loan?
Even though there are some ways an installment loan is better than other types of credit, there can be a few disadvantages too. Each payment a certain amount goes toward paying down the principle, or borrowed amount. And the rest goes toward the interest. Even though they have the potential of helping you improve your credit score, there are some ways to get yourself into some serious financial trouble.
- Don’t be tricked by interest rates. Look at how much you are actually going to be paying back. This includes the amount you initially borrowed along with any interest that was charged.
- Don’t be tricked into refinancing before you pay off the loan. You may be offered a “great deal” and even lower payments if you refinance the loan. There are some times it will lower your payment and it can be beneficial at times. But most of the time you are going to end up paying back way too much money in the long run.
- Watch out for insurance products. Sometimes lenders push insurance on you when you take out a loan. They will tell you that the loan will be covered in the event that you die or become disabled. You do not have to take this insurance if you don’t want the added expense.
- Sometimes lenders of small installment loans can use aggressive measures to try and collect the loan. In some cases they will call you even before your regular payment is due and hassle you to make the payments.
Should I take out an installment loan?
You are the only person who can determine if an installment loan is in your best interest. It can be very beneficial if you can fit it in your budget responsibly without overextending it particularly when you have a large expense need and no way to pay for it. Any loan should be a matter of consideration before it is made. But as you can see there are some distinct advantages for those who do get an installment loan when it is needed.