With so many loans on offer, knowing the specific details of each loan type can be difficult. So here you’ll find a short guide on instalment loans. We have covered what they are, the different types of instalment loans that are available, the advantages and disadvantages of these loans, how they affect your credit score, and how you can know if installment loans are right for you.
You can learn more about installment loans through other resources online, along with other useful information from the world of loans and finance.
What are Instalment Loans?
Instalment loans are a way to borrow money for a single large purchase. While there are exceptions, installment loans typically focus on purchasing assets like a house, cars, or education services. The lender approves the loan, as usual, and then the borrower receives the loan amount in a lump sum. Over an agreed-upon period, the borrower repays the loan over several payments. These are called installments, hence the name.
Instalment Loan Types
Here are some of the different types of loans that can be described as installment loans. Like most loans, they come under two broad categories – secured and unsecured. For those who don’t know, secured loans are where you put assets on the line and then lose those assets if you can’t pay the loan, like getting your car or property repossessed. Unsecured loans carry no such risk but typically have higher credit requirements to get accepted.
Business Loans
A business loan as an installment loan is similar to a loan for private individuals, but is used for business financing. You can use the commercial loan for setting up a business, for project financing and business growth financing, as well as to compensate for ongoing bottlenecks in revenue. Commercial buildings, machines and office equipment as well as open salaries can be covered with it. Depending on what you want to take out a business loan for and how high the loan amount should be, there are different options.
Personal Instalment Loans
Personal instalment loans have broad uses, so you can use them on pretty much anything once the money is in your hands. Whether it’s events like weddings, renovating your home, or paying off other bills, personal loans are offered by every bank and credit union. Some online lenders offer them too but you should vet the lenders to make sure they’re legitimate.
Mortgages
Mortgages are also a type of installment loan. They’re secured since they’re used to finance the purchase of property, so the home is held as collateral to protect the lender’s interests and ensure that you pay it back. It also keeps the interest rates low since the lenders are taking on less risk. If you can’t pay the mortgage, your home will get taken from you. This is an important fact to understand if you are a new home buyer looking for your 1st mortgage loan.
Student Loans
When installment loans are given by the government or private lenders to pay for education, they are student loans.
Payday Loans
Payday loans are a short-term loan that’s designed to help borrowers fulfill financial obligations until their next paycheck comes in. They have high-interest rates and fees attached to them, so everybody should fully assess their situation before making sure that it’s the right move for you.
Auto Loans
When used for the purchase of a car or a similar vehicle, installment loans are more specifically called auto loans. Like with mortgages, you will lose the car if you can’t keep making payments and this keeps the interest rate down.
Advantages & Disadvantages
Installment loans are just loans, so whether they are good for you or not depends on your needs, your current situation, and your credit score.
Here are some common benefits of installment loans:
- Paid back in predictable monthly payments, called installments
- Often have a fixed interest rate, making them more predictable
- Higher credit limits than credit cards
As for the common downsides of installment loans, take a look:
- While predictable, this also means they are less flexible
- Some borrowers will face high-interest rates, depending on your credit and the specific use of the loan
Relationship to Credit Score
Like any other loan, installment loan lenders rely on credit scores and other financial information to judge if you can pay the loan back in time. Installment loans then affect your future credit depending on how you pay them back. Here’s a simple breakdown of just how that works. Your credit score can generally be divided into three sections, payment history, credit utilization, and then credit mixing.
Payment History
The largest factor of anybody’s credit score is their history of making payments on previous debts and other financial obligations. In the typical FICO credit scoring model, it contributes to as much as 35% of the score. Making all your payments on time will strengthen your credit while missing them will make your credit score fall.
Credit Utilization
Another 30% of the standard FICO credit scoring model is related to credit utilization. This is where a ratio is calculated based on how much of your total credit you’re using at any one time. If you’re using all of your credit all at once then it’s a sign of financial irresponsibility, overburdening with debt, and a lack of budgeting, so it can lower your overall credit score.
Credit Mix
Mixing different forms of credit can prove beneficial to your credit score. Adding a loan to your credit report can give it a boost once you’ve been approved. It allows you to take on some debt and prove that you can meet financial obligations when you need to. You shouldn’t take out loans just to beef up your credit score, however, because this may lead to a hard inquiry where your score will dip temporarily.
When Are Instalment Loans Right For You?
With all of the above information in mind, you need to decide if instalment loans are ideal for you or not. They’ll affect how you budget your finances and your long-term credit, so it’s not a decision to be taken lightly.
Assess loan offers and budget for every monthly payment so that you can always pay them. Consider if there is a financial emergency, would you still be able to make your payments? Try to expect the unexpected and try to have savings that can help in those situations.
If you’re still unsure of whether installment loans are ideal for you, you should talk to your lender about alternatives that may be more palatable. They can also update your offer by extending the repayment period and lowering the installment payments as a result.
