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Installment loan paperwork

How Do Installment Loans Work?

Have you found yourself wondering, "How do installment loans work?" If so, you've come to the right place.

Without a financial background, installment loans may seem difficult to wrap your head around. After all, they come in many shapes and sizes. But there's no need to panic; consider this your ultimate guide to installment loans, their inner workings, pros and cons, and where to get them. 

Key Takeaways

  • Installment loans provide a fixed amount of money that you repay over regularly scheduled payments. Terms can range from a few months to 40 years, depending on the specific loan you receive.
  • "Installment loan" is an umbrella term encompassing various loan types, including mortgages, personal loans, auto loans, payday loans, student loans, and more.
  • Always consider the pros and cons before deciding to take out an installment loan.
  • Installment loans may make sense if you're financially stable enough to afford the repayments, meet the repayments on time, and are benefitting in some way from taking the loan out.

What Is an Installment Loan?

An installment loan offers you a fixed amount of money that must be repaid across regular payments. These loans come in many forms, ranging from loans that are used for certain financial goals (e.g., purchasing a house or funding a college education) to those used for various purchases (e.g., financial emergencies).

Generally, payments occur monthly, but regardless of the schedule, each one includes the debt's interest and a portion of the initial amount borrowed (known as the principal).

As for the amount, it changes depending on three major factors:

  • amount you borrow;
  • length of the loan's term; and
  • lender's rate.

Each payment stays the same throughout the term, ensuring it's easy to include in your monthly or weekly budgets. 

Are Installment Loans Secured or Unsecured?

Installment loans can be either secured or unsecured, depending on the terms of the loan agreement.

Secured installment loans require collateral, such as a car or a house, to back the loan. This collateral gives the lender some security, meaning if the borrower defaults on the loan, the lender has the right to seize the asset to recover the outstanding balance. 

On the other hand, unsecured installment loans do not require any collateral. These loans rely solely on the borrower’s creditworthiness and promise to repay. 

Installment loans

How Does an Installment Loan Work?

When you get an installment loan, you'll receive the money or item you're buying at the beginning of the term.

For example, you take out a mortgage and can live in, refurbish, and renovate the house once the agreement starts.

Another example, you receive a lump sum payment from an installment loan upfront, pay for whatever emergency item is outstanding, and repay the owed amount over a predefined period.

Once you've received the item or lump sum, you must stick to the regularly scheduled payment until it's repaid in full. As soon as the outstanding balance hits zero, the lender permanently closes your account.

Can You Get an Installment Loan with Bad Credit?

Yes, you can get an installment loan from most lenders with bad credit. However, your credit score may have an impact. Why? Because most lenders consider creditworthiness when deciding whether to grant you the loan.

When you have bad credit, keep in mind that you won't necessarily be graced with the most favorable terms, as lenders will often consider you a higher risk than somebody with good credit. 

In addition, if you have no credit or you’ve been turned down many times, you may want to focus on acquiring a secured loan, where lenders can use your assets to minimize the potential risks involved with lending to somebody with a rocky financial history.

6 Installment Loan Types

All installment loans operate similarly at their core. However, each type has its own functions and eligibility requirements. We'll take a look at six of the most popular installment loan forms here:

1. Personal Installment Loans

Personal installment loans are undoubtedly the most common type of installment loan around. In fact, they're so popular that 23.5 million Americans have one, as TransUnion data shows. But the question is — why are they so popular?

While there are many reasons for the boom in personal installment loans, one of the most long-standing is their versatility. Unlike mortgages, student loans, or auto loans, you can use a personal installment loan to fund any legitimate expense.

Not to mention that they tend to be unsecured, allowing you to borrow cash without risking your assets.

You can get a personal installment loan from credit unions, online lenders, banks, and private lenders with terms typically stretching from 24 to 60 months. And while the amount you receive depends on multiple variables, the caps tend to run between $100 and $10,000.

The two most common uses for these loans are:

  • Emergencies. Thanks to their fast approval process, they're convenient when you're faced with an unexpected car repair, medical bill, or veterinary fee.
  • Big-ticket purchases. Financial experts never recommend taking out personal loans to fund frivolous purchases. However, people across the country still utilize them for vacations, home improvements, and weddings.

Personal Loans vs. Credit Cards

Personal loans and credit cards offer many of the same features and allow you to borrow funds for any expense. On top of that, they both let you receive funds from a lender, make monthly payments, and improve your credit score when you use them correctly.

However, they have important differences that shouldn't be overlooked. Here's a brief rundown:

Personal Loans

Credit Cards

Offers an upfront lump sum

Provides ongoing access to a predetermined amount

Fixed monthly repayments throughout the loan's lifetime

Variable minimum payments every month

Typically used for larger purchases

Used for everyday expenses and shopping 

Come with origination and other types of fees

May have monthly or annual fees

 

Some come with 0% introductory periods

 2. Auto Loans

As the name suggests, auto loans are designed to fund vehicle payments. Despite many dealerships providing in-house financing plans, you can also acquire direct auto loans through banks, credit unions, and online lenders. Opting for the latter may reward you with more favorable terms and higher repayment flexibility, although this isn't guaranteed.

To get this loan, you'll typically put a deposit on the car or add your existing vehicle's trade-in value. Then, you'll finance the rest of the purchase price with the auto loan and repay in monthly installments until you've paid in full. 

If you're purchasing a new vehicle from a dealership or online lender, the process tends to be quick and easy. However, it might take longer if you're buying a used car from a private seller and pay for it through your bank or a credit union loan. Either way, it's still a secured loan backed by your vehicle.

3. Mortgages

Mortgages are used to purchase a house. Like auto loans, they are secured by the asset they help you to buy (i.e., the property itself).

While there are many types of mortgages, the most popular requires you to repay the money you've borrowed over 15 to 40 years. Offered by a plethora of financial institutions (e.g., national banks, online lenders, and credit unions), you slowly chip away at the borrowed amount with the option to overpay if you receive a financial windfall.

The loan limits are incredibly high, sometimes running as lofty as $1,000,000 to finance properties in expensive neighborhoods. As for the process, it can take anywhere from 30 to 60 days and beyond since lenders must ensure you can repay the loan based on your income, credit history, down payment, job stability, type of home, and total debt.

4. Student Loans

Both types of student loans (federal and private) are unsecured installment loans that are solely for college tuition and other expenses directly related to studying.

Generally, soon-to-be pupils choose federal student loans, which are offered by the Education Department through a streamlined application called FAFSA (Free Application for Federal Student Aid). They're available to any eligible student who requires the funding. Unlike other loans, you don't need to hit any credit score criteria, and you don't have to undergo a credit check. They've held the preferred student loan position for years, thanks to their unique benefits (i.e., loan forgiveness programs, etc.)

In contrast, private student loans base approvals on your creditworthiness, making it difficult for students to qualify. Said loans are disbursed by a range of financial institutions and online lenders, with each company harboring distinct eligibility requirements. Shopping around is essential if you go this route.

5. Buy Now, Pay Later Loans

Buy now, pay later (otherwise known as BNPL) loans split the cost of purchase into installments to make it more manageable. This financial vehicle, sparked by the unprecedented COVID-19 pandemic in 2020, has taken the online shopping world by storm. So much so that a Nova One Advisor report states the BNPL market is expected to reach $25.3 billion by 2033.

Offered by most online retailers, these by now, pay later schemes are a convenient way of affording things without amounting credit card debt. Not to mention they can be easier to acquire than traditional personal loans and have much shorter terms (i.e., a few weeks).

Like other types of installment loans, BNPL loans come in various shapes and sizes. Some providers necessitate a hard credit check; others don't. Some lenders report your repayments to the credit bureaus; others don't. 

6. Payday Loans

Payday loans are short-term, small-dollar loans that are designed to be repaid when you receive your next paycheck. The aptly named financial vehicle is intended to assist you during a crisis or when you can't qualify for a different type of credit. 

Both the terms and structure of the loan vary by from state to state and lender to lender. However, they're often capped at $500 and don't require a credit check to qualify. Oftentimes, your repayment habits won't be reported to the credit bureaus, so you don't have to worry about impacting your credit score by taking out a payday loan.

Installment loans info

The Pros and Cons of Installment Loans

Before deciding whether you should get an installment loan, you must consider the advantages and disadvantages.

Pros of Installment Loans

Installment loans come with the following benefits:

  • Easy budgeting. Your monthly repayment amount stays the same throughout your term. Therefore, you know exactly how much you need to cover it, making budgeting a breeze.
  • Can quickly cover a large expense. Only a select few have enough liquidity to buy huge purchases outright. Installment loans, particularly mortgages and auto loans, give you the chance to buy life's most expensive investments without excessive down payments.
  • Potential for credit score improvement. Repaying an installment loan in full without any late payments will improve your credit score.
  • Predictable end date. You can dictate how quickly or slowly you repay your installment loan when you select the term. And since the credit is revolving, you won't overspend. Thus, every payment takes you closer to the final repayment.

Cons of Installment Loans

Here are the drawbacks to consider:

  • Potentially long financial commitment. Some installment loans don't come with a long repayment period, but others certainly do. By agreeing to a lengthy term, you're committing to meeting regular payments for the next few years (or decades). Always practice due diligence and read through the terms and conditions carefully. You may be penalized for repaying the loan early.
  • Not open-ended. If you need more money in the future, you will not be able to add to your loan amount.
  • Inflexible. Unlike repaying a credit card, you won't be able to drop to a minimum payment option — installment loans simply don't have this option. As such, you may find yourself in a sticky situation if your income drops suddenly.
  • Credit scores often matter. You may not be able to qualify for all installment loans with a bad credit score. And even if you do gain approval, you won't be given the same terms as somebody with a near-perfect score.

Where To Get an Installment Loan

You can get an installment loan from a variety of places, including credit unions, banks, and online lenders. However, it's worth noting that each institution will boast different products, terms, and eligibility criteria. For instance, a local bank may provide you with a closing cost break, but you won't necessarily be able to access a wide product variety or be approved with a less-than-perfect credit score.

If you are dealing with an undesirable credit rating, online installment loan lenders, such as Simple Fast Loans, may offer convenient, easy solutions. Provided you have valid identification, an active checking account, a phone number, a Social Security Number, and are over 18, acquiring an installment loan online is relatively quick and easy.

That said, you should always use loan comparison sites to figure out which provider is best for you. And, if you're obtaining a mortgage, consider using a broker alongside banks and online providers.

Should You Get an Installment Loan?

Whether you should get an installment loan depends on your financial state and personal situation. However, it may make sense if you're financially stable enough to repay the loan, afford the monthly payment, and receive a monetary benefit from it.

On the other hand, if you're on the cusp of a job change, anticipate peaks and troughs in your earnings, or are financing a large, ongoing project, an installment loan may not be for you. After all, you don't want to end up in a situation where you over or under-borrow.

Alternatives to Installment Loans

Installment loans are handy tools if you're looking to finance a renovation, get quick access to cash, or cover a large expense. After all, they give you a lump-sum deposit that can be repaid for the next few months, years, or decades.

But despite their ability to handle nearly all legal expenses, they aren't the right option for everyone. So, if you've concluded that you need a different type of credit, consider these:

Lines of Credit

Personal lines of credit (otherwise known as PLOCs) are a direct, unsecured alternative to installment loans, providing increased flexibility due to their credit-card-esque operation. 

Made with long-term expenses or larger projects in mind, PLOCs let you borrow exactly what you need, whenever you need it. Of course, the amount is capped, and you can only withdraw cash during the aptly named "draw period," but it's one of the more versatile installment loan alternatives on the market.

Once your draw period closes, your line of credit transforms into a term loan. At this point, you must make the monthly payments.

Credit Card

If you don't have a solid financial plan/budget, credit cards can be tricky to manage. But with positive repayments and responsible usage, they can provide unique benefits — air miles and cashback tend to be the most popular.

As long as your balance is low toward the end of the month, you won't have to worry about paying excessive costs. Plan to meet each repayment on time and in full, but if you fall short a couple of times, at least make the minimum payment to avoid interest accrual.

Additionally, you must consider the fees. Most credit cards come with several charges, one of them being an annual fee that can range from $99 to $600. The most desirable rewards often come with higher annual fees and are available solely to borrowers with excellent credit.

Home Equity Line of Credit (HELOC)

If you have equity in your home and need to cover multiple major expenses, a home equity line of credit (a.k.a., a HELOC) is a good installment loan alternative. Property owners tend to use this revolving credit for academic-related expenses or extensive home renovation projects. 

Your equity dictates the amount you can withdraw. However, lenders often let you withdraw up to 85%. Like lines of credit, HELOCs offer a draw period, typically lasting for ten years, during which you can take out money as and when you need it. 

The main drawback? Your house becomes the collateral.

Installment loans come in various forms, including personal loans, auto loans, mortgages, student loans, and buy now, pay later plans. Despite their differences, they all operate on the same basic principle: you receive a lump sum upfront and repay it in fixed monthly installments over a set period. This predictable repayment structure makes them a popular choice for financing big purchases or consolidating debt.

However, it’s crucial to weigh the pros and cons before committing to a loan contract. Understanding the details of how installment loans work can help you make informed financial decisions and choose the best option for your needs. Dive into our detailed guide to explore the ins and outs of installment loans and ensure you’re fully prepared before taking the plunge!

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