Learn how installment loans work, what they are, examples of this type of loan, and the benefits of this loan option.
Are you curious about how installment loans work, what they are, and whether they are the right financial choice for you? Then you’ve come to the right place. In this comprehensive guide, we’ll go over everything you need to know about how this loan works, including examples, how to get one, frequently asked questions, and the benefits to look for in the best installment loans.
What is an Installment Loan?
This is a type of loan that breaks payments into smaller chunks paid back in regular intervals, known as installments. So, instead of paying off what you borrow in one lump sum, you pay it off in several payments over time.
Types of Installment Loans
There are several types of loans that fall under the installment category, meaning they are paid back by the borrower in several payments or “installments.” For example, personal loans, mortgages, auto loans, student loans, and buy now pay later loans all fall under the installment category.
Personal Loans
Personal loans are used for various personal purposes like debt consolidation, home improvements, medical expenes, or other unexpected or emergency expenses. This loan is usually given to the borrower in one lump sum and then paid back by the borrower in several installment payments over time.
Mortgages
Mortgages are used to finance the purchase of a house. It’s also a type of secured loan, using the real estate property as collateral to help secure this larger loan. This type of loan is usually paid back in regularly scheduled payments over the course of 15 to 30 years, depending on your mortgage agreement.
Auto Loans
Auto loans are used to finance the purchase of a car. It’s also another secured version of this type of loan, using the car as collateral to help secure the loan. It’s usually paid back in monthly payments for several years until the car is paid off.
Student Loans
Student loans are used to finance the costs of higher education, like tuition and fees. These loans can come from the government or private lenders and often come with several types of repayment plans like income-driven repayment plans.
Buy Now Pay Later Loans
Buy Now Pay Later Loans (BNPL) are used to finance larger purchases for customers that can’t afford the cost all at once, but can afford to make several payments over time.
For example, you might need to buy a new computer but can’t afford to spend all that money in one lump sum. With a BNPL plan you could finance the purchase to get your computer today but pay it off over a few payments over time.
How Do Installment Loans Work?
They work by funding the borrower the money they need or paying the relevant parties directly for what the borrower is purchasing. Then, the borrower pays off what they borrowed in regularly scheduled payments over a period of time. All of this information is outlined in the loan agreement the borrower signs.
Step 1: Submit an application
The first thing you’ll do is submit a loan application with your lender of choice. This process may look different depending on what type of loan you are getting and what lender you are working with. For example, if you’re getting a car loan, the dealership you’re working with might help facilitate this process with a lending option they often work with.
Step 2: If approved, get money
If your application is approved, then the next step will be for the loan agreement to begin. Depending on the type of loan, the borrower might receive their funds up front, or the lender might pay the relevant parties directly. For example, if you get a personal loan, you’ll receive the money yourself. But if you get a car loan or a mortgage, the lender will probably pay the car dealership or the original homeowners directly instead of handing any money to you.
Step 3: Pay off in installments
The final step in this loan’s process is for the borrower to start making payments. Your loan agreement will outline how the payment process will work and what your payment schedule will look like.
These payments usually occur on a monthly basis with fixed monthly payments, but the specific repayment terms can vary depending on the lender and the loan agreement. Each payment will include a portion of the principal amount borrowed and accrued interest and any applicable fees. As you make your payments, you'll gradually pay down the balance of the loan until it is fully repaid.
Do installment loans affect your credit score? Any type of debt can affect your credit score if you don’t make on-time payments. Make sure you are looking at your budget before entering into a loan agreement to be sure you can take on the associated payments comfortably. Opting into autopay can also be a smart way to make sure your payments are always made on time.
What’s the difference between secured vs unsecured installment loans? Secured examples of this type of loan include mortgages and auto loans that use a home or a car as collateral to help secure the loan.
Unsecured loan examples include personal loans that don’t have any type of collateral to secure the loan agreement. If a loan is unsecured, then there may be more qualifications you need to meet, like a good higher credit score for example, in order to get approved.
What is the difference between a personal loan and an installment loan? These words are often used interchangeably and are often very similar types of loans. Essentially, a personal loan is a type of installment loan and an installment loan is a broader loan category that includes any loan that is repaid in regular installment payments.
Are payday loans a type of installment loan? No, there are no payday installment loans. Payday loans are a type of short-term loan or small-dollar loan. They are usually for a smaller loan amount and are repaid in one lump sum payment rather than several payments.
How to Get an Installment Loan
To get this type of loan there are a few things you’ll want to do to prepare before you apply for an installment type of loan.
First, you’ll want to look at your financial situation to check things like your income, monthly budget, bank account funds, and current credit score. You want to make sure this is the right option for you and that you are financially prepared to take on a fixed monthly payment before you start the application process.
Next, you’ll want to research multiple lenders to make sure you pick a reputable, licensed lender with loan terms that work for your situation. You want to get the best loan for your needs, so researching multiple lenders to find someone reputable and trustworthy is a must.
Finally, you’ll want to gather information and documentation you might need for the loan application process, like forms of government ID, paystubs, credit or payment history, or bank statements. What you need exactly will depend on the loan offered and the lender, but these items are a good place to start.
The Benefits of Installment Loans
There are several benefits to this type of loan and reasons why people choose them. Whether you want to consolidate debt or a personal installment loan for unexpected car repairs, there are many ways this financial solution can help.
Fixed Monthly Payments
The loan terms for this type of loan are usually stable monthly payments that don’t fluctuate. This can vary depending on the loan, lender, and loan agreement, but usually this type of loan comes with a fixed monthly payment that stays the same and can be easily planned into your monthly budget.
On-Time Payments Can Boost Credit Score
A positive payment history can potentially boost your credit score, showing other financial institutions in the future that you can make on-time payments. Make your payments on time and you can potentially see a positive impact on your credit score.
Predictable Payoff Date
Unlike other forms of debt, like credit cards, these loans come with a predetermined payoff date, so you know exactly when you’re all done. Since this isn’t a form of revolving credit, like a credit card, there is a clear payoff date for when the borrowing cycle is over and you can count yourself debt-free once again.
Can Cover Large Expenses
This borrowing option can help cover large expenses when you can’t afford a large expense all at once. This can really come in handy when you have necessary but high expenses to cover that can’t wait several months or several years for you to slowly save up for them. Instead, you can make use of this financial tool to help finance large expenses and break them down into more affordable chunks.
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