5 Pros and Cons of Installment Loans You Need to Consider

installment loans

Maybe you’re not familiar with the term installment loan. But if you’ve ever borrowed money to pay for your education, your car, or your home, you’ve likely taken one out.

After all, you received a lump sum from a lender and agreed to pay it back over time — or in installments.

Whether you already have an installment loan or are considering taking one out, you’ll want to know more about their finer details.

What are installment loans?

Unlike riskier payday loans, installment loans don’t need to be repaid in full all at once.

Also, installment loans are different from an open line of credit (or revolving credit), as you can’t add to your principal balance after your loan has been disbursed.

For example, a credit card is a type of revolving credit because you can keep borrowing until you’ve hit your card’s credit limit.

Unless you alter your repayment plan with your lender, you pay back your installment loan in equal monthly payments. You cover the initial debt and its accruing interest over a predetermined amount of time.

A $1,000 loan carrying a 15% interest rate over 24 months, for example, would have a monthly payment of $48. The final cost of borrowing the original $1,000 would be $1,164.

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How to find an installment loan

Because an installment loan can refer to a student loan, auto loan, or home loan, to name a few examples, you can find one from a variety of lenders. If you borrowed money for your college tuition, for example, you had the option of receiving loans from the federal government or a private bank.

Aside from banks and newer online lenders, credit unions might be your best option for personal loans. They’re community-oriented nonprofits that can offer greater flexibility on the loan terms you receive. Their payday alternative loans (PALs), for example, cap interest rates at 28%, far below those set by payday lenders and some online banks.

As with any loan, however, you’ll want to compare rates from multiple types of lenders before choosing the most favorable offer. You can evaluate lenders by considering the following criteria:

  • Loan amount
  • Interest rate (fixed or variable)
  • Term length
  • Repayment plan
  • Fee structure

To prepare their offers, reputable lenders take a hard look at your credit history and debt-to-income ratio, among other factors. If you have a subpar credit score and a lot of outstanding debt, you’re unlikely to score a competitive interest rate on a personal loan.

Why you might want an installment loan

Yes, installment loans can be disbursed for all sorts of purposes. If you’re financing a college education, car, or home, it’s pretty obvious why you’re considering installment loans.

But you might also be thinking about covering holiday costs with a personal loan. Say you plan to spend $1,000 on flights, a hotel room, and gifts for family and friends. Without space in your budget, you might consider a loan that can cover the cost of your holiday celebrations. Afterward, you can focus on repaying your loan.

That’s the blessing and the curse of installment loans — and why you might be tempted to use one for various purposes. Like a credit card, these loans allow you to spend money you don’t actually have, which can be both useful and dangerous.

2 pros of installment loans

First, the blessing: Installment loans allow you to delay a large but necessary expense by making small payments over time. Although the interest rates are typically high, the long-term costs could be made up for by the short-term relief.

Here are the pros of installment loans.

1. Repayment terms

Like all loans, installment loans need to be repaid in a set amount of time. If you find yourself needing to borrow for a worthy cause, however, an installment loan can secure you the funds.

This is why it’s important to know what you want out of an installment loan before you start shopping for one. If you know your finances will allow you to repay the debt in three years instead of one, focus on lenders that’ll give you more time to pay it off.

2. Paying a little bit at a time

Aside from a potentially longer loan term, the chief advantage of installment loans is that you can repay your debt in chunks instead of all at once.

Just ensure that you can afford the monthly payment before taking out your loan. Failure to repay your loan can harm your credit score and limit your ability to take out other lines of credit or accomplish other financial goals.

3 cons of installment loans

Now, the curse: Installment loans create a debt that you have to repay over time. Although they can be repaid in smaller chunks, missing one payment can cause your debt to increase dramatically.

Here are three cons of these loans to consider before borrowing.

1. Payday loan-like features

Not all lenders are created equally, so you’ll have to be wary of installment loan lenders that offer dangerous payday loan-like features, such as high interest rates and short repayment terms.

You’re particularly vulnerable if you don’t have a strong credit score or steady income. If that’s the case, you might see lesser-known lenders offer no- or bad-credit loans with instant approval. These loan agreements can come with exceptionally high interest rates and fees. Plus, your credit could be hit harder if you fail to keep up with payments or, worse, default on the loan.

There are also ways to borrow cash quickly without resorting to these disguised personal loans. Credit unions’ PALs, for example, offer consumer protections, like a maximum $20 application fee and a minimum repayment term of one month.

2. Growing interest

Because they’re paid off in installments, these loans will cost you more in interest the longer it takes you to pay them off. This makes getting a low interest rate all the more important.

If you can afford to wait before taking out an installment loan, use the time to improve your credit score. It could save you hundreds or thousands of dollars in accruing and capitalizing interest.

3. Hidden prepayment penalties

By their definition, installment loans can be repaid before the end of your loan term without incurring a penalty. If you can pay off your debt before the term’s end, you should. You’ll save on any interest that would have accrued.

If you pay off that $1,000 personal loan for the holidays in 12 months instead of 24, for example, your final bill will be $1,083. If you don’t pay off your debt early, you’ll pay $1,164 in total.

Be wary of less-reputable lenders hiding prepayment penalties in the fine print of your loan agreement. Not all installment loans are built the same way, so do your due diligence before signing.

Before taking out an installment loan

Before taking on debt, know that you have other options. You might be more familiar with student loan alternatives, like grant aid, scholarship awards, and work-study programs. These help you pay for school without putting you into debt.

As for the alternatives to personal loans, consider ways to avoid bad online lenders. You might request a paycheck advance from your employer, for example.

If taking out an installment loan is your best path forward, take both the positives and negatives into account. Your future self will thank you for it.

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1 Includes AutoPay discount. Important Disclosures for SoFi.

SoFi Disclosures

  1. Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi’s underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Finance Lender Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org)
  2. Personal LoansFixed rates from 5.49% APR to 14.24% APR (with AutoPay). Variable rates from 4.98% APR to 11.44% APR (with AutoPay). SoFi rate ranges are current as of December 21, 2017 and are subject to change without notice. Not all rates and amounts available in all states. Not all applicants qualify for the lowest rate. If approved for a loan, to qualify for the lowest rate, you must have a responsible financial history and meet other conditions. Your actual rate will be within the range of rates listed above and will depend on a variety of factors, including evaluation of your credit worthiness, years of professional experience, income and other factors. Interest rates on variable rate loans are capped at 14.95%. Lowest variable rate of 4.98% APR assumes current 1-month LIBOR rate of 1.34% plus 3.89% margin minus 0.25% AutoPay discount. For the SoFi variable rate loan, the 1-month LIBOR index will adjust monthly and the loan payment will be re-amortized and may change monthly. APRs for variable rate loans may increase after origination if the LIBOR index increases. The SoFi 0.25% AutoPay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account.

2 Important Disclosures for Citizens Bank.

Citizens Bank Disclosures

  1. Personal Loan Rate Disclosure: Fixed interest rates range from 5.99% – 16.24% (5.99% – 16.24% APR) based on applicable terms and presence of a co-applicant. Lowest rates shown are for eligible applicants, require a 3-year repayment term, and include our Loyalty and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty Discount and Automatic Payment Discount disclosures. Subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change.
  2. Loyalty Discount: The borrower will be eligible for a 0.25 percentage point interest rate reduction on their loan if the borrower has a qualifying account in existence with us at the time the borrower has submitted a completed application authorizing us to review their credit request for the loan. The following are qualifying accounts: any checking account, savings account, money market account, certificate of deposit, automobile loan, home equity loan, home equity line of credit, mortgage, credit card account, student loans or other personal loans owned by Citizens Bank, N.A. Please note, our checking and savings account options are only available in the following states: CT, DE, MA, MI, NH, NJ, NY, OH, PA, RI and VT. This discount will be reflected in the interest rate and Annual Percentage Rate (APR) disclosed in the Truth-In-Lending Disclosure that will be provided to the borrower once the loan is approved. Limit of one Loyalty Discount per loan, and discount will not be applied to prior loans. The Loyalty Discount will remain in effect for the life of the loan.
  3. Automatic Payment Discount: Borrowers will be eligible to receive a 0.25 percentage point interest rate reduction on their Citizens Bank Personal Loan during such time as payments are required to be made and our loan servicer is authorized to automatically deduct payments each month from any bank account the borrower designates. If our loan servicer is unable to successfully withdraw the automatic deductions from the designated account two or more times within any 12-month period, the borrower will no longer be eligible for this discount.
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