Borrowing money and paying it back in equal monthly payments is a handy personal finance tool that helps consumers pay off sizable debts in small, manageable chunks.
Personal loans are one of the many types of so-called “installment loans” that consumers can use to pay off existing high interest debt, such as credit cards, home improvements or unexpected expenses.
The interest rates for credit cards are typically in the double digits, increasing the amount of time it takes to pay down the principal amount of the charges if the borrower doesn’t pay off the card in full each month. Current credit card rates are averaging nearly 18 percent, according to Bankrate.
Consumers who don’t qualify for 0 percent or lower interest balance transfer offers can opt to obtain a personal loan since the interest rates are often less than the rates for credit cards.
“A personal loan is made without any collateral, typically in modest amounts compared to larger loans like auto loans or mortgages,” says Greg McBride, CFA, chief financial analyst for Bankrate.
The other types of installment loans include no credit check, mortgages and auto loans.
What’s an Installment Loan?
Installment loans require the consumer to pay back the money borrowed each month at a fixed interest rate for a certain amount of time. The payments typically remain the same each month with a portion going towards the principal amount and another percentage paying for the interest on the loan. The fixed payments helps consumers budget for expenses.
“An installment loan is any loan where the amount is borrowed up front and repaid in even monthly payments, or installments, over a predetermined amount of time – such as a mortgage, car loan, or student loan,” McBride says.
Types of Installment Loans
No credit check loans
These loans are often provided by payday lenders who don’t check your credit score before lending you money. Payday loans are intended to help consumers out during an emergency when they don’t have another source of credit.
The amount of the loan is typically smaller and is limited to only $500 to $1,000. The fees are also very high compared to credit cards. Consumers often pay $10 to $15 for every $100 they borrow, which adds up quickly. The purpose of these loans is to provide quick cash to a consumer until the person receives his or her paycheck in a week or two weeks.
Payday loans are often the worst loans a consumer can get because they are expensive. But that’s not the only downside. When a consumer defaults, punitive damage can occur, depending on the laws within the area the loan was taken, says Jim Triggs, a senior vice president of counseling and support at Money Management International, a Sugar Land, Texas-based nonprofit debt counseling organization.
“Unfortunately, there is a segment of the consumer borrowing population who depend on payday loans to get by when they need an influx of cash and have no other means,” Triggs says. “There are other fintechs getting into the microloan space, but most still fall short on consumer fees and interest rates.”
A fixed-rate home loan is another common installment loan. The most popular mortgages require homeowners to pay back the money borrowed during the next 15 or 30 years with a fixed rate. Since a mortgage is backed by collateral, such as a house or condo, the interest rates tend to be lower and more affordable to consumers.
Car loans are another popular type of installment loan. These loans are similar to mortgages, as they require consumers to pay off the loan during a set time period with a fixed interest rate. Car loans are usually run three to seven years in length.
Pros of Installment Loans
Installment loans have many advantages. The biggest, perhaps, is that the monthly payments remain the same for the duration of the loan. When a payment is made each month, a percentage is paid toward the principal amount of the loan, or the amount of money that was borrowed. The remainder of the payment goes toward the interest on the loan.
Knowing how much a payment is each month for your home or car is helpful because it makes it easier to create a budget and pay those bills on time each month. And a clean payment history with no late payments improves a person’s credit score.
Installment loans, such as mortgages and car loans, can also be refinanced. When interest rates fall or when a consumer’s credit score improves, refinancing into a new mortgage or car loan can be beneficial because it likely will lower the monthly payment or reduce the length of the loan. That helps a consumer save money over the long run and potentially pay off the loan sooner.
Consumers can also make extra payments toward a mortgage or auto loan in order to pay off the loan more quickly.
“The more often a person is able to pay beyond the required monthly payment, the sooner he or she will pay off the loan without having to pay the interest for the full term,” says Bruce McClary, spokesman for the National Foundation for Credit Counseling, a Washington, D.C.-based nonprofit organization. “Using this strategy is a good idea no matter how your loan payout schedule is structured, but it always produces the best results when is becomes a regular habit.”
Cons of Installment Loans
Since installment loans allow a person to borrow money at a set amount, you can’t increase the debt later on. For instance, if you run into a fresh financial hurdle or emergency, you can’t increase the amount of a personal loan like you can with a credit card.
Another disadvantage of an installment loan is that you have agreed to pay off a larger loan over a lengthy period of time. Car loans are often at least four years and can stretch to seven years. A consumer needs to make sure that he or she can make payments on time each month for that length of time.
The interest rate you receive from an installment loan also depends on your credit score.
In general, installment loans are a good way to borrow sizable sums of money with reasonable payback schedules.
Many people obtain personal loans to consolidate their debt, usually at a lower interest rate. Having one payment to make each month is also helpful.
Where to Find Installment Loans
Installment loans are very popular and can be obtained through a bank, credit union or online lender. Shopping around will help you receive the lowest fees and interest rates.
You can easily apply for a mortgage, car loan or personal loan online. Personal loans are often approved quickly in the same day or week, while car loans and mortgages require a more extensive and longer check into your credit history and credit score.