Examples of Installment Credit
To make this a comprehensible article about installment credit I want to first define it. If you want to just see the examples, they are down below in this article.
So What is Installment Credit
Installment credit is a type of credit that allows someone to borrow a certain amount of money from a lender and repay it. Usually, a set amount of money is paid monthly over a predetermined period of time. This type of credit is commonly used for large purchases, such as homes, cars, and college education that people may not be able to afford upfront.
How Installment Credit Works
The process begins when someone chooses a lender and a loan amount. Once the loan terms are agreed upon and documents signed, the lender gives the money either directly to the person or the place of business the person is wanting the desired purchase. When someone takes out an installment loan, they agree to repay the lender that amount of borrowed money plus interest over a certain period of time. The repayment is usually monthly; with each payment going toward both the principal and the interest. Usually more money will go toward the interest initially and start shifting a little more toward the principle as the loan gets paid down. The interest rate can be fixed or variable, depending on the terms of the loan.
Installment loans can have a significant impact on a borrower’s credit score. On-time payments can improve the borrower’s credit history, while late or missed payments can negatively affect it.
Examples of Installment Loans
- Mortgages: These are loans that cover the purchase or refinance of a home. It’s most common to make monthly payments to repay this debt, but most of the time you are able to make bi-monthly payments. The length of time, normally, to repay this type of loan is between 15 and 30 years, depending on the loan terms and interest rate. Mortgages are secured by the property you buy, which means you can lose it if you don’t pay on the loan.
- Auto loans: These are loans that cover the cost of a new or previously owned car. Monthly payments are normal for this type of loan and the duration, most of the time is from 3 to 7 years, depending on the loan terms and interest rate. Auto loans are also secured by the car you buy, which means you can lose it if you default on the loan.
- Student loans: These are loans that cover educational costs such as tuition, books, room and board. You will have to repay these loans once you graduate, leave school or drop below taking a certain amount of classes. There is normally some grace period that starts when you become eligible for repayment. Some 6 months and others a year. The length of time you will repay depends on how much you borrowed and interest rate. Student loans are either federal or private, and may have different benefits and eligibility criteria.
- Personal loans: These are loans that cover debt or are used to make desired purchases, such as debt consolidation, home improvement, medical bills and the list goes on. You usually have to make monthly payments for 1 to 7 years, depending on the loan amount, terms and interest rate. Personal loans can be either secured or unsecured.
Pros and Cons of Installment Loans
Like any financial product, installment loans come with their own set of advantages and disadvantages.
Advantages
- Convenience: Installment loans allow us to make large purchases without having to save up the full amount and pay all at once. This can be particularly beneficial for items like homes or cars, which typically cost a lot. This can help you achieve your financial goals and improve your quality of life.
- Affordability: By spreading out the cost of a purchase over time, installment loans can make expensive items more affordable. You have predictable payments that stay the same every month, unless you have variable rates, pay extra or miss a payment, which can lead to extra fees. This can make budgeting easier and help you plan for the future.
- Lower Interest Rates: You usually get lower interest rates than with revolving credit, such as credit cards. This means you pay less interest on the amount of money you borrowed which will save money in the long run.
- Improves Your Credit Score: Your credit score can be improved by making on-time payments on your installment loan. Your payment history is one of the most important factors in your credit score, and paying on time shows lenders that you are responsible and reliable.
- Ownership: With an installment loan, we own the item outright once the loan is paid off. This is different from leasing or renting where we will never own the item.
Disadvantages
- Total Cost and Fees: While installment loans can make large purchases more affordable in the short term, the interest and fees associated with these loans can add up over the length of the loan. This makes the total cost of the item significantly higher than the original price. If you miss a payment on your installment loan, you may have to pay a late fee to the lender. This can add up quickly and increase your total cost of borrowing.
- Impulsive Spending: Installment loans can make you more likely to buy things that you don’t really need or can’t afford, especially if you agree to a high interest rate or a long repayment term. This can lead to overspending what you make and accumulating more debt than you can handle.
- Risk: If a person is unable to make their loan payments, they risk damaging their credit score and potentially losing the item if it was used as collateral for the loan. A lower credit score can mean paying more interest on other loans or not being able to get them.
- Financial Dependence: Installment loans can create a cycle of debt that is hard to break free from. If you rely on installment loans for any of your monthly expenses, such as rent, utilities, groceries, etc., then eventually you will need another loan when that money runs out and that money will run out before you have repaid the entire loan. This means you will need another loan, a higher loan, to either finish repaying the first one or to continue paying the payments of that one in addition to your monthly expenses.
- Debt: Taking on an installment loan means taking on debt. This can impact a person’s ability to take on additional credit and can potentially lead to financial hardship if not managed properly.
Tips on Using Installment Credit
- Make Your Payments on Time: Your payment history is a significant factor in your credit score. Making your installment loan payments on time shows lenders that you’re reliable and can manage your debts responsibly.
- Keep Credit Usage Low: Try to use around 30% or less of your available credit. High credit utilization can negatively impact your credit score.
- Maintain Different Types of Credit: Having a mixture of different types of credit, like installment loans and credit cards can positively impact your credit score. It shows lenders that you can handle various types of credit.
- Choose the Right Repayment Terms: Consider your financial situation and choose repayment terms that allow you to comfortably make your payments. Longer terms could result in more interest paid, but if you are considering paying it off quicker you can save interest this way.
- Don’t Borrow More Than You Need: It can be tempting to borrow extra money, but it’s important to borrow only what you need. This helps ensure you can make your payments and reduces the amount of interest you’ll pay.
- Monitor Your Credit Report: Regularly check your credit report to make sure your installment loan and other credit accounts are being reported accurately. If you spot any errors, dispute them immediately.
Installment credit is a powerful financial tool that can help you afford large purchases. Just make sure you understand all the terms of the loan and how you are paying it back. This is how to make informed decisions that support your financial health and goals.