What Is An Installment Loan And How To Get One?

“Installment loan” is a fairly vague term, and it’s no wonder - most of us have at least considered, if not taken on, an installment loan once or twice in our lives. That’s because installment loans cover a wide variety of financing options.

To help you understand what you’re dealing with here, let’s break down the pros and cons, answer some commonly asked questions, and discuss some textbook examples of installment loans.

What Is An Installment Loan?

An installment loan is every loan that you get to repay in fixed amounts over a pre-set period. These payments are commonly known as installments, hence the name installment loan.

Payment schedules are usually organized in monthly sums you have to deliver. The specific amount depends on several factors: The loan principal, interest rate, and the length of the loan. Each of these payments covers a portion of the principal amount borrowed and the accrued interest on the debt.

When you’re paying off loans in installments, everything is calculated in advance, and all costs are fixed throughout the loan term. In other words, you’ll know exactly how much you need to set aside each month in advance. This is one of the most enticing aspects of installment loans, as they rarely come with unpleasant surprises.

Calculating your budget with an installment loan is incredibly simple; not only that but, on top of giving you the funds you need to get what you want, this type of financing can also help build your credit score.

Examples of Installment Loans

There are plenty of different installment loans, but here is an overview of the most common ones.

Mortgages

A mortgage is a kind of installment loan that people looking to buy property typically rely on. Mortgages come in two shapes: Flexible and fixed. In other words, some mortgages allow for changes in the interest rate throughout the length of your loan term.

However, most mortgages include fixed installments and rates. Standard 15- or 30-year fixed-rate mortgages are the most common solution for purchasing a home with a loan.

A second mortgage can be a home equity loan, and it works on the same principle - you receive funds in a lump sum, which you later repay in installments.

Car Loans

Auto loans are a typical variant of installment financing. Usually issued with a 12-96-month term, the exact conditions will depend on the borrower’s monthly budget.

It is generally better to get as short a loan term as possible, even if it means purchasing a less-than-ideal vehicle. Longer repayment terms can be costly due to the interest you will accrue.

Personal Installment Loans

Personal loans are installment loans one would typically take out to cover a sudden expense or afford something they wouldn’t be able to otherwise, such as medical bills or home renovation projects.

The terms are similar to those of an auto loan - between 12 and 96 months - but the interest is usually more significant, as personal loans are often unsecured. Taking out a personal line of credit is often a good solution too, but those won’t always be enough to cover your expenses.

Types of Installment Loans

Apart from use-case distinctions, the most common categorization for installment loans is between secured or unsecured loans.

What makes a loan secured or unsecured is collateral. For example, a mortgage is a secured loan because the house you’re taking it out for is set up as collateral. The same goes for an auto loan: The vehicle you buy serves as collateral. Secured loans generally don’t involve a lot of risk for the lender, so their interest rates are on the lower side.

Unsecured installment loans don’t require collateral, which sounds great, until you realize that makes them much more difficult to get approved for and carry high interest rates.

Loans without collateral require the borrower to be creditworthy, meaning that they need to have a good credit score and a history of regular payments. First-time borrowers rarely get approved for unsecured loans.

And because a loan without collateral represents a higher risk for your lender, as there are no assets on the table that would guarantee the lender will get repaid, your interest rates will be far less favorable.

Pros And Cons

There are both some advantages and disadvantages of these loans.

Installment Loan Advantages

One significant advantage of installment loans lies in the possibility of getting a loan amount much bigger than you would with other options. What’s more, the interest rates are also lower than, say, the interest on credit cards. You can tailor the amount to your needs and budget, and negotiate terms such as loan length and interest rate with your financier.

People with a bad credit score will also have more luck getting approved for this type of loan, especially for online installment loans, when compared to other options.

The installments are usually pre-defined and unlikely to change throughout the loan term. In other words, you’ll know exactly how much they factor into your monthly budget. There’s also the option to set up automatic payments, practically letting the loan take care of itself.

Additionally, if you pick the right loan, you can save on interest, especially if the loan terms do not include prepayment charges for paying the principal off earlier. Making sure what you’re getting is one of the best deals available will make it more likely for the loan to perform its other function: Building your credit.

Installment Loan Disadvantages

Taking out an installment loan is typically a very long-term commitment, which can cause two sets of problems:

For one, changing the installments pre-fixed at the moment of taking out the loan is nearly impossible. The set amount won’t change even under unexpected circumstances, such as job loss, illness, or simply the inability to meet your payments each month. If the loan payments are not completed according to the installment plan, by definition, the borrower faces defaulting the loan or losing the collateral. Of course, late or missed payments can also harm your credit score.

The less troublesome - but still significant - issue with installment loans is that the market rate for interest also changes over time, sometimes drastically. Sometimes this means paying higher interest compared to the current interest payment trends. On the other hand, this could also work to your benefit, as the prevailing interest rate might be lower. This is a gamble for the lender as well, so the scales can tip to either side.

“How do loans work?” is a difficult question, due in no small part to the fact that correctly predicting the loan amount you need rests solely on you. Taking less than you need could turn into a severe problem, but taking too much, together with occasionally high loan fees, can be an even bigger issue.

The Effect of Installment Loans on Your Credit Score

Taking out an installment loan and paying it off regularly can be an excellent way to build your credit. After all, payment history is the main factor in determining your credit score, and any regular payments and generally responsible credit use help improve it.

After all, if you have a good payment history, but the other credit factors are bringing your score down, many online installment-loan lenders will overlook the bad score and approve you for the loan.

Of course, failing to make your payments on time, or ever, hurts your credit score. This is a major red flag for lenders, so setting up automatic payments to avoid accidentally damaging your credit might be wise.

How To Apply For An Installment Loan

Applying for an installment loan is simple, but can be time-consuming. The biggest trick is finding a lender who will give you satisfactory loan terms.

The process of getting an installment loan starts with filling out an application form with a particular lender, stating the intended purpose of your loan.

The next step is meeting with the lender to discuss the loan terms. Based on the loan type, you will settle on the collateral, evaluate your credit score, and look over all the options for your loan - the term length, loan payment schedule, required down payments, etc.

The lender will then determine whether they’re willing to take the risk of lending you money. If not, you can always try with another lender, opt for other kinds of loans, like personal installment loans. Getting a loan with bad credit is often tricky, but it’s not always easy for creditworthy people, either. The interest rates can be far from reasonable, so make sure your potential lender comes highly recommended.

After the loan is issued, all you have to do is pay the installments on time to avoid excess charges. It is also a good idea to pay off the loan as quickly as possible - provided there are no penalties for doing so with the chosen lender.