Installment loans: how they work and examples

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An installment loan is a common type of loan that is widely used toward the purchase of a car, house, or other major purchase. You may even have an installment loan that goes by a different name, e.g. B. a mortgage. Here is what an installment loan is and what you should know about these types of loans before taking out a loan.

What is an installment loan?

An installment loan is a lump sum that you borrow and repay in installments – or installments – over a period of time, usually months or years. Installment loans can come with collateral, such as a car, or a unsecured.

Installment loans work differently than revolving loans – which you get with a credit card or line of credit for home equity loans – in that you borrow the funds all at once. You cannot get more money without applying for a new loan. And installment loans give you more time to repay the loan, unlike payday loans which require a full repayment of your next paycheck.

Examples of installment loans

Personal Loans: Personal Loans are installment loans that you can take advantage of for almost any reason. Available loan amounts range from $ 1,000 to $ 100,000, and repayment terms are typically two to seven years.

A lender uses information such as credit history and score, income, and other outstanding debts to determine whether you qualify for a personal loan and what interest rate you pay.

Unsecured personal loans are more common than secured personal loans, but some lenders allow borrowers to use a savings or investment account or vehicle as collateral on the loan in order to potentially obtain a lower interest rate.

Home Loans: With a home loan or mortgage, you borrow the value of the house and agree to repay it with interest in monthly increments, usually over 15 or 30 years.

In this case, the installment loan is secured by the home and you risk losing it after too many defaults.

A home equity loan – which is a second mortgage you may be able to take out for home renovation – is also an installment loan.

Car Loans: A car loan is another example of a secured installment loan. You borrow the cost of the vehicle and pay monthly payments plus interest over two to six years. If you miss payments, the lender can repossess your car.

Student Loans: Student loans are installment loans because you pay them back in regular installments over time. However, they can have fixed or floating interest rates and usually include a period after you borrow the money when the interest accumulates but the monthly payments have not yet been put in place.

How installment loans affect your creditworthiness

Applying for an installment loan usually requires one tough credit checkthat can temporarily lower your credit score by a few points. Plus, installment loans can boost your credit score – as long as you make consistent, on-time payments.

Reputable lenders report on-time payments to at least one of the three major credit bureaus Equifax, Experian, and TransUnion. Payment history makes up 35% of your credit history, and on-time installment loan payments help build that history.

The consequences of missing or late payments can be serious. A payment that is more than 30 days late can degrade your credit score by 50 to 100 points. Most lenders have the option to set up automatic payments, which removes the pressure of remembering the payment.

How to get an installment loan

  • Compare. Lenders use different methods to evaluate your loan application and assign your interest rate so it may be worthwhile to compare installment loans from multiple lenders. Also consider other forms of financing, such as low-interest credit cards or lines of credit, which can be cheaper, especially for large expenses.

  • Classify beforehand. Having pre-qualified for a personal loan or pre-approved for a mortgage allows you to see potential loan amounts, interest rates, and payments without affecting your creditworthiness. You can then assess how the payments will affect your budget.

  • Boost your application. Before you apply, consider a joint or co-signed installment loan or secure an unsecured loan with collateral. These options can help you qualify or get a lower interest rate or higher loan amount. Be aware that if you cannot repay the loan there are consequences: your co-signer is on the hook or the collateral could be withdrawn.

  • Apply. Installment loans are available from banks, credit unions, and online lenders. The time required to apply varies depending on the loan type and lender; Online lenders usually offer faster processes.

Private installment loan with poor creditworthiness

Borrowers with thin or incomplete credit profiles may be able to get an installment loan with a bad credit rating (under 630 FICO). Some lenders have lower credit requirements and consider other information such as bank account transactions, employment, education, and existing debt. Credit unions and online lenders usually deal with borrowers with poor credit scores, while banks tend to charge good to excellent credit.

High-priced personal installment loans

Lenders must disclose the annual percentage of a loan (interest rate plus all other fees), and personal finance experts say 36% APR is the maximum rate for a loan to be affordable.

But you can find some installment loans with interest rates of 100% or higher. Lenders who offer high interest installment loans may not verify your creditworthiness and ability to repay the loan, or report on-time payments to the credit bureaus. These are red flags that signal that the loan is too expensive at best and at worst predatory.

Alternatives to the installment loan

A personal installment loan can be an expensive way to cover an emergency. Try these options out first.

  • Borrow money from a friend or family member. It might be humiliating to ask someone you trust for money, but it can be cheap or interest-free. Draw up a loan agreement stating when you will pay it back and what interest you will pay. Be careful with this option so as not to endanger the relationship.

  • Explore other ways to make money. Sell ​​clothes, ride a rideshare, test websites, or take surveys to make money when you have the time.

  • Borrow from your next paycheck using a loan app. Loan apps give you access to a small portion of your earned wages, usually for little or no fees. However, it can also result in overdraft fees or repeated borrowing, so it is best to use it as a last resort in an emergency.

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