Top 3 alternatives to installment loans

Installment loans are a handy tool for anyone looking to fund a large expense, finance a renovation or get access to cash quickly. The funds are disbursed in one lump sum and paid off in equal monthly payments (installments). While they can be used for nearly every legal expense, the immediate repayment and interest rates can make them a costly financing choice, especially for those with low credit.

If an installment loan isn’t right for you and you need the funds quickly, consider the alternatives, like a personal line of credit, a credit card or a home equity line of credit.

When to consider an alternative to installment loans

While installment loans can be used for various expenses, it doesn’t necessarily mean they’re the best option for every situation. For example, most installment loan lenders require that individuals have at least good credit and meet an annual income requirement. If you don’t meet most of the lender’s minimum requirements, you may want to see if you can delay taking on debt and work toward improving your credit score.

While some companies cater to borrowers across the credit spectrum and approve those with low credit, these loans often come with high interest rates and fees. This means that if you’re unable to make your monthly payments, your score will suffer, and you could end up paying thousands in interest accrual alone.

You’ll also want to consider an alternative if financing an ongoing, large project. You can only borrow up to a specific amount with an installment loan. If you end up in a situation where you under- or over-borrowed, you’re stuck with the balance until it’s paid off in its entirety. However, some lenders allow borrowers to take out a second loan after they’ve made payments for a specified amount of time.

Lines of credit

Not every lender offers personal lines of credit (PLOC) — especially if you’re looking for an unsecured option. Despite this, they are a worthwhile alternative to a personal loan. They offer more flexibility than a personal loan and often have a lower interest rate than a credit card.

Ideal for larger projects or long-term expenses, a PLOC operates similarly to a credit card but with much lower interest rates. With a PLOC, you can borrow what you need, when you need it — up to your credit line — during the draw period and only have to make interest-only payments. When your draw period ends, your line of credit becomes the equivalent of a term loan, and you’ll then be responsible for making monthly payments.

However, you may be required to provide some form of collateral, especially if you’re borrowing a larger amount. Collateral is an asset or property that backs the loan balance. Lenders use collateral to minimize risk for larger loan amounts or to secure loans for bad credit borrowers. If you default on the balance or fail to make the payments over a period of time, your collateral can be seized to satisfy the delinquent payments.

In the case of a PLOC, the details may differ between lenders. Still, you can expect to use a savings account, investment account or a certificate of deposit (CD) as collateral. While unsecured credit lines are less common, some lenders may offer them to the most creditworthy individuals.

Benefits

• Flexible spending.
• Only pay interest on the amount you use during the draw period.

Drawbacks

• Less lender options.
• Collateral may be required.

Credit cards

Credit cards can be difficult to manage if you don’t have a tight budget or a solid financial plan. They often come with higher interest rates than loans or other financing options, which makes it easier to accrue large amounts of high interest debt. However, with responsible usage and positive repayment, a credit card can offer exclusive and unique perks, like cash back and travel rewards.

Before taking out a credit card, conduct a financial audit to create a realistic credit card budget to avoid overspending. The high interest rates that most cards carry only become an issue if you fail to make the payment at the end of your billing period.

The lower your balance at the end of each month, the less interest you will pay. Ideally, you’ll make each monthly payment on-time and in-full, but if there are one or two months where the funds come up short, make at least the minimum monthly payment to avoid interest accrual. While it may be helpful to use once or twice, only making the minimum payment isn’t recommended as a long-term solution as it will cause your monthly payments to skyrocket.

Keep in mind that credit cards also come with a fair share of fees, including an annual fee. This can range anywhere from $99 a year all the way up to $600 a year. Typically, the best rewards or travel cards come with annual fees on the higher side and only cater to customers with excellent credit. What’s more, you also need to spend up to a specific amount to take full advantage of the card’s benefits, so make sure this amount doesn’t result in overspending.

Benefits

• Membership perks like cash back or travel rewards.
• No interest if you pay off the amount you spent before the billing cycle ends.

Drawbacks

• High interest rates compared to personal loans.
• May come with steep annual fees.

Home equity lines of credit

A home equity line of credit (HELOC) is the best option if you’ve built up equity in your home and need to cover a series of major expenses. For example, larger home renovation projects or academic-related expenses, like housing costs or tuition, are best for a HELOC. Plus, if you use the funds to improve, buy or build your home, the interest is tax-deductible.

The amount you can take out depends on the equity you have in your home, although most lenders allow you to take out up to 85 percent. Much like lines of credit, HELOCs allow you to take out what you need when you need it during the draw period, which generally lasts 10 years.

The major drawback of a HELOC is that your house acts as the collateral for the line of credit. So if you can’t make the payments, your lender has legal jurisdiction to pursue foreclosure to satisfy the delinquent balance. However, the foreclosure process isn’t immediate, and your lender may be willing to negotiate or extend alternate payment plans, but it is a risk.

Because HELOCs are a secured debt, the, rates and fees tend to be lower than other loans and financing options. Plus, they’re generally easier to qualify for, so those with less-than-stellar credit have a better chance of approval. Still, you’ll need to meet the income and credit score requirements to secure the lowest rates.

Benefits

• Potential to deduct interest for certain expenses.
• Some lenders only require interest-only payments during the draw period.

Drawbacks

• Risk foreclosure if unable to pay.
• Home appraisal and other fees may be necessary.

The bottom line

Installment loans may be a convenient option when you need to cover a big expense, but they’re not as flexible as other options, like a credit card or a PLOC. However, no matter the route you take, always compare multiple options and weigh the lender’s minimum requirements against your financial health before applying.