What is an installment loan? Definition and examples
An installment loan is a type of loan that allows individuals to borrow money and repay it in installments over time. The amount borrowed is often a large sum. Installment loans are often used to purchase items that consumers cannot afford to pay for directly with cash.
What is an installment loan?
An installment loan will specify an interest rate, the required payment schedule as well as penalties for missed payments. Installment loans can allow prepayments, although there may be prepayment penalties in some cases.
Some installment loans may require collateral, such as a home loan and a car loan. The purchased home and the vehicle for which the loan is taken out are the collateral in these examples. There are also unsecured installment loans, such as personal loans, which can be used for various purposes.
How to qualify for an installment loan?
As with any type of loan, the borrower will consider a number of factors when evaluating your installment loan application.
- Your credit score. As with any type of loan, the better your credit rating, the more likely you are to be approved. A FICO score of 700 is generally considered good, a score of 800 or higher is generally considered excellent. A higher credit score will also help you qualify for a lower interest rate.
- Your credit history. This includes factors such as your history of paying your debts on time and any judgments, bankruptcy or other public default on record.
- Your debt-to-income ratio (DTI). This represents the total of all your monthly obligations and debt payments to your monthly income. Those with lower DTI ratios are perceived as having better credit risks by lenders.
- Income verification. Lenders will want to know that you have a stable and reliable source of income that will allow you to make all payments in full and on time.
- For some installment loans, collateral may be required to provide security to the lender. In the case of a loan against an asset such as an automobile or a house, this asset will serve as collateral for the loan. In other cases, you may need to provide additional guarantees. This may include cash set aside or a lien on other assets you may own.
What are the benefits of an installment loan?
One of the biggest advantages of an installment loan is the predictability of payments. Most installment loans have a fixed monthly payment over a set period. This makes budgeting easier and can help you with your overall financial planning.
The fixed term provides the comfort of knowing that if you make all payments in full and on time, the loan will be repaid in full on a specified date.
Paying off an installment loan can help build your credit history and can demonstrate to creditors that you are a good credit risk in that you pay your debts on time.
An installment loan can help you afford to make major purchases without having to dip into cash reserves that are earmarked for other purposes. This is an advantage as long as you don’t overwork yourself taking out the loan.
Where can you get an installment loan?
There are several places to get an installment loan. A few include:
- Banks are a preferred source for various types of installment loans, including auto loans, mortgages, and personal loans. While banks are accepting new customers all the time, it can be helpful to be a current customer. If you anticipate that you will have future borrowing needs, it may be a good idea to establish a relationship with a bank early on, starting with a checking account and a savings account.
- Credit unions serve members based on the organization they work for, an affiliation such as the military, a geographic region, or other. Credit unions often have lower rates and better terms on installment loans than banks for borrowers with average or poor credit.
- Online lenders are becoming more prevalent. Whether it’s online banks, credit unions, or one of the many lenders that operate exclusively online, this avenue offers another alternative for many borrowers. Online lenders are available for all types of installment loans and cater to lenders with a variety of financial situations and borrowing needs. The application process is also often quick and streamlined.
Examples of installment loans
A fixed rate home loan is a classic example of an installment loan. The term of the loan is fixed; Terms of 30 or 15 years are common. Principal and interest payments are also fixed, although your overall payment may vary based on changes in your local property taxes if these payments are escrowed and paid by your mortgage lender.
The property serves as collateral for the loan and can be seized by the lender if you fail to repay the loan.
At the end of the loan term, assuming you have made all required payments, the loan is paid off in full and you own your home upfront and clear. Mortgages generally allow for additional principal repayments allowing the borrower to repay the loan sooner. If the property is sold before the mortgage is repaid, the loan will have to be paid from the proceeds of the sale or other assets of the seller if the remaining amount of the mortgage cannot be covered by the proceeds of the sale.
A car loan is a fixed term installment loan. Loan terms of three or four years are common, but longer-term loans are increasingly available to allow borrowers to finance more expensive vehicle models.
Auto loans are available from banks, credit unions, and various online lenders. Additionally, dealerships typically have relationships with lenders, including their own captive lenders in some cases. It’s a good idea to shop around for the best rate and terms before buying a car to ensure you’re getting the best deal.
The vehicle serves as collateral for the lender, the vehicle can be repossessed if you fail to make the payments on the loan.
Personal loans can be used for a variety of purposes, including consolidating other expensive debts or unexpected expenses such as medical bills. The term of the loan can vary, usually from 12 months to 96 months or more.
Personal loans are generally unsecured, so interest rates are usually a bit higher than other types of installment loans. There are a variety of lenders that offer this type of loan, so shop around before making your decision.
Installment loans can offer a fixed rate solution for your borrowing needs, including a major purchase or debt consolidation.
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