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Sometimes, things happen in life that leave you in a bind.
A sudden illness, losing a job, or even unexpected car repairs can cripple your monthly budget.
How do you pay for these extra expenses and still have enough to cover the bills?
An installment loan offers an easy and quick solution to unforeseen money woes. But should you be getting one?
How Do They Work?
An “installment loan” is a blanket term for personal and commercial loans. This type of loan is often used to fund big purchases, like a house or a car.
Here’s how it works.
The lender provides a borrower with a fixed amount of money. The loan must be repaid through scheduled installments, usually done monthly. Each payment on an installment debt includes:
1) Repayment of a portion of the principal amount borrowed
Three variables are used in determining the amount of a scheduled loan payment:
- Amount of the loan
- The interest rate charged to the borrower
- Length or term of the loan
Types of Loans
The installment loan, as mentioned above, can either be a personal loan or a car loan. But there are other types too.
Described below are the four most common types you’ll encounter.
You borrow the house’s value you intend to purchase with a home loan. You pay the mortgage with interest in monthly increments for a specified period.
Home loans usually take 15, 25, or 30 years to pay.
A home equity loan is also an installment loan. It is a second mortgage you might take to pay for home improvements.
An auto loan has a similar concept to a mortgage. Only this time, you borrow the cost of the vehicle. You make monthly payments, and if you miss any, the lender can repossess your car.
Student loans fall under the installment loan umbrella. They can have fixed or variable rates, but you make regular payments either way.
A student loan includes a period after you’ve borrowed the money when interest accumulates, but monthly payments haven’t kicked in.
Unlike the first three examples, a personal loan is useful in different ways. The lender decides whether you qualify for it. The bank you’ve applied with will then do an assessment. Your income, credit history, credit score, and other outstanding debt are reviewed to see if you’re loan-worthy.
Some lenders let you use an investment account or offer collateral. This can potentially qualify for a lower rate.
Payday loans are technically a type of installment loan. It has a much shorter payment term, higher interest rates, and no credit check required.
Pros and Cons
Installment loans are flexible. The loan terms can be adjusted to fit your ability to repay it. You can also obtain financing at a substantially lower interest rate than revolving credit financing, like those on credit cards. You keep more cash on hand for other purposes rather than making a large cash outlay.
The scheduled payments stay the same throughout the life of the loan. As a borrower, you get to enjoy fixed payments that fit your budget.
However, if you have a longer-term loan, you could be stuck making fixed payments at a higher interest rate. Higher than the current market rate. And future circumstances could leave you incapable of meeting scheduled payments.
Is It for Me?
There’s an installment loan for most financial needs. Whether you’re thinking of just having money to cover next month’s rent or buying your dream home, chances are there’s a loan product for you.
The key is to do research. Know the options you have and compare them. And get pre-qualified for a personal loan or preapproved for a mortgage. You can see loan amounts and payments without affecting your credit score, then assess how the payments impact your budget.