An installment loan can be the best available financing resource when you need a large sum of money for something that you have not been able to save enough to pay for in cash. Installment loans are also important tools for building your financial future when used appropriately. There are various common installment loan types, including auto loans, student loans, mortgage loans, and both collateralized and uncollateralized personal loans. These and other kinds of loans are available through many types of lenders, including banks, credit unions, loan companies, and even privately funded lending groups and individuals.
TIP: Relying on credit cards to make small payments on large purchases is generally adverse to financial health. Keeping credit card balances well below the maximum credit limit and paying them off monthly is the most financially beneficial way to manage credit cards. Installment loans typically offer lower interest rates and payment structures that make sense based on the borrower’s ratio of income to expenses.
What Are Installment Loans?
An installment loan is an amount of money borrowed under an agreement to repay it over a period of time with an agreed number of pre-scheduled payments. Installment loan payments and interest rates can depend on a range of factors. These can include the amount of the loan, the purpose for which the money is borrowed, the borrower’s credit status, and the lender’s interest rates, and other lending policies, among other factors.
TIP: Try to pay additional amounts above your agreed installment payments. Be sure to specify that those extra amounts (“principal payments”) are to be applied directly to reducing the principal of your loan. Paying even small principal payments helps you pay off your loan before the agreed maturation date, which reduces the amount of interest you will pay over the life of your loan.
When Is an Installment Loan the Best Option?
There are pivotal times in life when installment loans are the best way to borrow money. For some examples, installment loans can enable you to make important investments in your future:
- Vehicle Purchase — An auto loan is one of the most common of all installment loan types. It enables billions of car owners worldwide to obtain cash upfront to pay for a road-worthy automobile over a period of months to years. That means they can own a car or obtain the funds for a deposit without depleting their bank accounts.
- Investment in Education — For so many of today’s college graduates, Federal student loans are a fact of life, paying for high tuition costs at interest rates that are often higher than ideal. When in need, a Short Term Installment Loan can help cover educational needs or payments
- Home Investment — Mortgages are installment loans that are collateralized using the house and property to secure the debt. Mortgage loans are typically long-term loans (commonly for 30 years). Short Term Installment Loans can also assist in staying up on mortgage payments when you are in need of immediate assistance to make your payment
- Career Investment — You might determine that taking some evening courses or relocating to a different city for work, or buying some equipment is necessary for your career. Often such investments in your business or professional career future are larger than you can absorb into your personal career or business operating expense budget. But, if the investment makes sense for your future ability to increase your income, then a personal loan is an essential resource. It allows you to acquire the funds you need at a fixed payment amount to cover any expenses needed.
- Paying a Large Unexpected Expense — An Installment loan can be a critical financial resource if you find yourself faced with an unexpected major expense. For example, if your car or house suddenly needs a major repair or someone in your family has an uncovered medical expense, and you need funds quickly, a short term installment loan can be an essential alternative.
Common Types of Loans
As you can see from the examples above, there are likely to be times in life when an installment loan can be a very important financial tool. For a more thorough consideration of your financing options, compare the various types of installment loans, to determine which is the best kind of loan for you?
- Title loans — A title loan is generally a high-interest collateralized loan that uses your car title, or boat, motorcycle, or other title to personal property as security against the lender’s risk. This means that if you default on the loan terms, the lender can seize your car or other property used to secure the loan.
- Payday Loans — A payday loan is a cash advance on your next earnings. This is an unsecured loan. This form of financing is different from an installment loan. Payday loans are generally extremely high-interest loans, and often have staggering additional fees for late payments.
- Credit Cards — Credit cards are important financial tools when used in a disciplined way. That means keeping balances low and paying off the balance in full monthly, to avoid interest payments. But, credit card balances amount to loans with variable interest rates, frequently costing cardholders much more than they would have paid for purchases in cash. Credit card interest is also compounded, which means the cost of using the borrowed money can escalate very rapidly on unpaid monthly balances.
- Collateralized Installment Loan — As discussed in sample scenarios above, a collateralized loan is a practical way to acquire funding needed for large purchases, such as real estate, automobiles, business assets, etc. Using collateral to secure a loan helps make the applicant a better candidate for a large loan, because he or she is providing protection for the lender against risk of default.
- Uncollateralized Installment Loans — An unsecured installment loan offers borrowers an excellent option for obtaining cash quickly for necessary expenses or important investments, if managed properly. The process to apply for an installment loan, especially for smaller loans of a few thousand dollars or less, is typically relatively quick, and people can acquire funding without promising collateral for security.
When the amount borrowed and the payments agreed are kept within the borrower’s financial means, an unsecured installment loan can substantially increase your capacity to buy things you need and foster long-term financial health.
TIP: Keep in mind that although it can be very tempting to commit to longer repayment terms with smaller payments, by the end of the loan period, you will have paid more than you would have with over a shorter repayment period, because interest on the remaining unpaid principal continues to accrue as long as the loan is not yet paid in full.
When interest is compounded, which is common for many lenders across virtually all loan types, it can become disproportionately costly to repay a loan of any type over a prolonged period. Compounding interest means that as interest accrues on the unpaid loan principal, more interest is then charged on the unpaid interest itself.
Determining Your Best Financing Option
Weigh your financing alternatives carefully, to determine the best type of loan for your needs and your financial position. The best kind of loan for your current needs depends on the combined factors of your situation. Above all, keep sight of the fact that some loan types are not conducive to financial health and do have lasting consequences, especially when not handled very carefully. When selecting a loan type, prioritize these considerations:
- The lender’s interest rate
- The number, frequency, and amount of payments
- Length of time it will take to pay off the loan
- All additional possible fees in addition to the payment amount
- Any restrictions or stipulations not clearly explained in the agreement
- How quickly you will receive the proceeds of the loan
Your top priority should be to make sure that paying loan payments is going to be practical for you at your level of income and with all your other expenses. Taking on debt that you cannot repay can lead to a personal financial crisis and serious emotional and mental strain.