An installment loan is a type of loan that allows individuals to borrow money and pay it back 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 outright with cash.

What Is an Installment Loan? 

An installment loan will specify an interest rate, the timing of required payments as well as any penalties for missed payments. Installment loans may permit early repayments, though there may be prepayment penalties in some cases.

Some installment loans may require collateral, examples include a home mortgage and an auto loan. The home being purchased and the vehicle for which the loan is being taken are the collateral in these examples. There are also unsecured installment loans such as personal loans that can be used for a variety of purposes.

How Do You Qualify for an Installment Loan?

As with any type of loan, the borrower will look at a number of factors in evaluating your application for an installment loan.

  • Your credit score. As with any type of loan, the better your credit score, the more likely you are to be approved. A FICO score of 700 is generally considered good, one of 800 or above is generally considered to be excellent. A higher credit score will also help you receive a lower interest rate.
  • Your credit history. This includes factors like your history of paying your debts on time and any judgements, bankruptcies or other public blemishes on record.
  • Your debt-to-income (DTI) ratio. This represents the total of all of your monthly obligations and debt payments to your monthly income. Those with lower DTI ratios are perceived as better credit risks by lenders.
  • Verification of income. Lenders will want to know that you have a source of stable and dependable 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 for the lender. In the case of a loan against an asset like an automobile or a home, that asset will serve as collateral for the loan. In other cases, you might have to provide additional collateral. This might include cash that is set aside or a lien on other assets you might own.

What Are the Benefits of an Installment Loan?

One of the biggest benefits of an installment loan are the predictable payments. Most installment loans have a fixed monthly payment over a fixed period. This makes budgeting easier and can help with your overall financial planning.

The fixed term offers the comfort of knowing that that if you make all payments in full and on time, then the loan will be paid in full by 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 tap into cash reserves that are earmarked for other purposes. This is an advantage as long as you don't overextend yourself by taking out the loan.

Where Can You Get an Installment Loan?

There are a number of places to get an installment loan. A few include:

  • Banks are a prime source for various types of installment loans including auto loans, mortgages and personal loans. While banks take new customers all of the time, it can help to be a current customer. If you anticipate that you will have future borrowing needs, it can make sense to establish a relationship with a bank early on, starting with a checking and savings account.
  • Credit unions serve members based on the organization they work for, an affiliation such as military, a geographic region or other. Credit unions often have lower rates and better terms on installment loans than banks for those borrowers with average or poor credit.
  • Online lenders are becoming increasingly prevalent. Whether online banks, credit unions or one of many lenders whose business is exclusively online, this avenue offers another alternative for a lot of 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 often fast and streamlined as well.

Examples of Installment Loans

Mortgage

A fixed-rate home mortgage is a classic example of an installment loan. The term of the loan is fixed; 30-year or 15-year terms are common. The payment for principal and interest is fixed as well, though your overall payment can vary with changes in your local property taxes if these payments are escrowed and paid by your mortgage lender.

The property serves as the collateral for the loan and can be foreclosed on by the lender if you default on the loan.

At the end of the loan term, assuming you've made all required payments, the loan is paid in full and you own your home free and clear. Mortgages generally allow extra payments of principal allowing the borrower to pay off the loan sooner. If the property is sold before the mortgage is paid off, the loan will need 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 sale proceeds.

Auto Loan

An auto loan is an installment loan for a fixed term. Loan durations of three or four years are common, but longer-term loans are becoming increasingly available to allow borrowers to finance more expensive vehicle models.

Auto loans are available through banks, credit unions and various online lenders. Additionally, dealerships generally 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 shopping for a car to ensure you get the best deal.

The vehicle serves as security for the lender, the vehicle can be repossessed if you fail to make payments on the loan.

Personal Loans

Personal loans can be used for a variety of purposes including consolidating other high cost debt or unexpected expenses like medical bills. The term of the loan can vary, generally the range is from 12 months to 96 months or more.

Personal loans are generally unsecured, so the interest rates are generally a bit higher than other types of installments loans. There are a variety of lenders who 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 consolidating debt.

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