It’s important to fully understand the potential benefits and drawbacks of an installment personal loan before obtaining one. Here are the main characteristics of an installment loan:
- Predictable monthly installments and fixed interest rates
- Flexible repayment terms with many prospective lenders to compare
- Allows you to build better credit through regular loan payments
- Potentially lower interest rates than other financing strategies
- Enable major purchases you can’t otherwise afford upfront
If you’re uncertain about whether an installment loan is the right choice for you, you can consult with a financial advisor and benefit from their expert guidance.
Installment loans are a personal loan subtype where the borrowed money needs to be repaid by regularly scheduled payments (AKA installments). These installments divide the loan into smaller chunks, making it more manageable for individual borrowers to manage.
Like other personal loans, an installment loan can help you finance a major purchase, handle emergency expenses, pay for events, and enable you to reach your financial goals. Let’s go over what you need to know about installment loans, their pros and cons, and what factors to consider before obtaining one.
Definition of installment personal loan
Installment personal loans are repaid over time with a set number of scheduled payments, which is designated in the loan agreement.
In contrast to installment loans, single payment loans require you to repay the loan amount (plus any interest) in a single go. Single payment loans often have short loan terms, giving you only a few weeks to repay the debt. Otherwise, you would have to pay extremely high interest rates.
Because of the high risks and costs associated with single payment loans, it is often advisable to choose installment loans over single payment payday loans, title loans, pawn shop loans, and bridge loans.
Features of an installment personal loan
1. Principal amount
The principal loan amount refers to how much is borrowed. Loan providers will tell you your minimum and maximum loan amount, with different lenders having varying requirements and restrictions.
The principal loan amount plays an essential role in interest calculation. The higher your principal, the more interest you will end up paying over the life of the loan (assuming the interest rate stays the same).
2. Interest rate
The interest rate is the percentage of the principal that is charged by the lender as the cost of borrowing. Interest rates typically fall in between 8 percent and 36 percent.
While most personal loans have fixed interest rates, you could also opt for a variable interest rate. A fixed rate loan has the same interest rate throughout the loan term, letting you anticipate the exact installment amount every month.
The interest rate you receive in a loan offer is affected by numerous factors, including:
- Your credit score
- Desired loan amount
- Loan purpose
3. Loan term
The loan term usually refers to the duration of the loan, also known as the loan tenure. When it comes to an installment loan, the loan term can vary greatly depending on your needs and the lender’s requirements. If you take out a large loan to finance a significant purchase, you might prefer a longer loan term so you have ample time to repay it.
On the other hand, if you want to quickly repay the debt so less interest accumulates, you might benefit from a shorter loan tenure.
4. Monthly payments
Most installment loans expect you to make equal payments spread over the loan term, with one payment per month. However, some installment loans might have you make bi-weekly payments or on another schedule instead of the standard monthly payments.
A monthly payment usually includes a portion of both the principal amount and the interest. This combined cost remains the same throughout the term of the loan. To further increase the predictability and convenience of repaying an installment loan, you can even set up automatic loan payments so the regular installments will be automatically deducted from your account each month.
5. Fixed vs. variable interest rates
Most personal loans come with fixed interest rates. This means the interest stays the same throughout the life of the loan (unless you manage to negotiate new loan terms). This predictability can be helpful for many borrowers. However, loan providers usually offer fixed rate loans with higher initial interest rates than variable rate loans.
A variable rate loan has an interest rate that fluctuates over time depending on numerous factors, such as market conditions. This makes how much you pay each month more unpredictable. While you could spend less on interest, this is not guaranteed.
It’s important to choose a type of interest rate that makes the most sense to you. If your chosen loan term is short, a variable rate loan might benefit you more since the interest rate is less likely to spike up during this time. On the other hand, a long tenure might make a variable interest rate too unpredictable to be worth it.
Advantages of installment personal loans
Installment personal loans are characterized by their fixed monthly payments, which makes it easier to budget for debt repayment. You can expect to pay the same amount every month.
With a personal loan, you can always choose a lender and repayment schedule that aligns best with your needs. For example, you can choose a repayment period and loan tenure that matches with your income and financial standing.
Access to larger loan amounts
Installment loans typically allow you to access larger sums than payday loans, credit card cash advances, and other financing methods. This allows you to more easily cover large purchases, emergencies, and consolidate debt.
Having an active installment loan allows you to potentially establish good credit. Making on-time payments toward your installment loan shows creditors that you are creditworthy and capable of managing debt.
Convenient application and pre-qualification processes
Many installment loan providers let you go through the application and pre-qualification processes online. You can finish the application from the comfort of your home through a few mouse clicks. By taking advantage of pre-qualification and pre-approval, you can save even more time.
Disadvantages of installment personal loans
Interest over time
With an installment personal loan, it is unfortunately possible that you end up paying a lot more than the principal loan that you obtained. This is especially true if you took out a large principal loan amount with a long loan tenure.
Still, an installment personal loan can finance a goal that is otherwise out of reach. It is important to weigh the pros and cons of the loan before making a decision.
Potential for overborrowing
Borrowers of installment loans might be tempted to borrow more funds than needed because of the high maximum limits. Overborrowing money can lead to unnecessary financial strain and extra debt.
Fees and penalties
While origination fees are not as popular as they used to be, many personal loans still come with origination fees and other additional charges.
In addition, be wary of early repayment penalties if you plan on repaying the loan early.
Potential for a debt cycle
If an installment loan is not managed properly, it can lead to a frustrating cycle of debt. Late payments can result in more interest accruing and your credit score being damaged. As borrowers rush to repay debt that is overdue, they may undertake more financial strain.
Good financial habits and debt management can help a borrower avoid a debt cycle. If you’re struggling with debt, consider consulting with a financial expert or credit counselor for individualized guidance.
It’s vital to consider the potential negative impact on your credit. If you cannot make payments consistently and on time, the late payments can cause significant credit score damage. Defaulting on a loan would hurt your credit score even more, dropping it by at least a hundred points. Loan defaults and missed payments can both show up on your credit report for up to seven years.
Common uses of installment personal loans
Personal loans are a highly versatile financing method. Once loan funds are disbursed into your bank account, you can use them for any approved loan purposes. There are only a few exceptions you may not be able to use a personal loan for, such as investments, college tuition, or down payments for homes.
Here are the popular uses of installment loans.
Personal loans are an accessible and convenient way to consolidate debt. An advantage to using an installment loan for debt consolidation is that you can roll multiple debts into one. For example, if you have a payday loan, high credit card balance, or other installment loans that are tough to manage, it can be beneficial to consolidate all of these debt obligations into a single monthly payment.
Home improvements and repairs
Many borrowers take out installment personal loans to fund home improvement and home repair costs. Buying a pool, renovating a bathroom, and remodeling a kitchen are all popular home improvement projects that can cost a hefty amount of money. A personal loan facilitates paying for these expensive home improvement plans.
An added benefit to using a loan for home upgrades is that you can even increase the value of your property, which essentially lowers the cost of borrowing.
Unexpected medical bills can cause a serious depletion of personal savings. A gap in health insurance coverage can also result in unforeseen extra expenses. Since timely medical treatment often makes a meaningful difference in treatment outcomes, a personal loan can be invaluable when it comes to financing healthcare procedures.
Common medical emergency bills that can be covered by a loan include:
- Surgery costs
- ER visit
- Doctor bills
Buying a car, home appliance, or other expensive item can be too strenuous on your personal savings without the help of a loan. Many borrowers use personal loans for major purchases so they can spread out the expenses over a long loan term, avoiding the huge upfront costs.
Weddings and other special occasions
Dream weddings and other events can cost tens if not hundreds of thousands of dollars. A personal loan is one strategy to fund large, important events so that you don’t need to put your other financial goals and needs on hold.
Factors to consider before taking out an installment personal loan
Need vs. want
First, ask yourself whether the loan is for a necessity or a luxury. While there isn’t necessarily anything wrong with obtaining a loan for something like a luxurious vacation, it’s generally advisable to take out personal loans for goals and needs that are top priority.
Repayment capacity is an essential factor to consider. Can you comfortably afford the monthly payments? If not, are you able to adjust your budget and prioritize loan repayment so that you don’t spiral into more debt? It’s critical to go into an installment personal loan with a clear idea of how you’re going to repay the loan.
Before committing to a particular loan, try shopping around for the best rate. With modern technology, comparing loan terms online has become quick and accessible. Make sure you look at the different interest rates and annual percentage rates (APRs) so you’re aware of the cost of taking out the loan.
A shorter loan term might have higher monthly payments, but less interest will accrue over time.
Meanwhile, a longer loan term has more manageable, smaller monthly installments. However, you might have an overall higher cost of borrowing with the increased interest over time.
Make sure that you research the lender's credibility and look at the customer reviews before you choose a particular loan provider. Finding a suitable, reputable lender can greatly improve your borrowing and repayment experience.
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