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What Is an Installment Loan and What Are Some Examples?

loan contractYou hear about all kinds of loans every day. Loans for your car, loans for your home, and even loans to pay for those medical bills that you weren’t expecting. But, when you go to your bank or other service provider, what are you getting? Answer: an installment loan.

If you’re looking for, say, installment loans, California has plenty of options available to meet your needs — but you want to ensure that you understand what you’re getting prior to signing on the dotted line.

In short, an installment loan is the borrowing of a lump sum of money which will be paid back over a fixed period of time depending on the terms of the loan.

Installment loans typically have a fixed interest rate, meaning that the payments would be the same throughout the term of the loan. Some loans have adjustable interest rates, meaning that they amount of the interest that you pay (and consequently your total payment amount) can change over the life of the loan.

Some loans will be secured by collateral, while others are unsecured and provided with the promise of repayment.

Collateral is what is provided as additional guarantee of the promise to repay the loan. Should the borrower default on the loan, the lender takes ownership of the collateral.

There are numerous types of installment loans on the market, but they typically fall into a few categories: home loans, auto loans, and personal loans.

  • Home Loans. Home loans or mortgage loans are the monies paid to purchase a house. Mortgages have varying loan terms, but the most common loan periods are 15 and 30 years. Most have a fixed interest rate, but there are home loans that are issued with a variable interest rate. This means that the interest rate can be adjusted up or down depending on the terms outlined in the mortgage. The adjustment in the interest rate is usually tied to variations in market interest rates. A home mortgage is secured by the home and so if the borrower defaults on the loan, the lender will take over ownership of the home.
  • Car loans. If you don’t purchase your car for cash, the car dealer will usually help you by providing financing for the purchase of your car. The terms of the loan will vary depending on the lender but could be as few as 1 year (12 months) to as many as 7 or 8 years (84-96 months). Pay careful attention here as while longer payment terms will result in lower monthly payments, the overall cost of your car purchase will likely be higher.
  • Personal loans. Personal loans are installment loans that cover any number of purchases. Some people use them to pay unexpected bills like medical expenses or car repairs, while other loans may be taken for a planned family vacation or business investment. One of the most common types of personal loans are student loans which are used for higher education expenses. Personal loans have a wide variety of repayment terms and interest rates. Payday loans are meant to be short term loans but typically have extremely high interest rates and fees associated with them, while loans from more traditional financial institutions usually have more standard interest rates.

The terms of the loan you qualify for will depend heavily on your credit history. For example, someone with excellent credit will usually receive a lower interest rate and favorable terms than someone with fair or poor credit.

Benefits

Installment loans make it so that you don’t have to come up with the cash for your major purchases up front. As the typical installment loan has a fixed income payment, this allows you to budget for your purchase, knowing that the payment amount will remain unchanged over the term of the loan.

Drawbacks

If you have an unexpected expense and take out an installment loan, only to later find out that the cost will be higher, you don’t have the ability to add the additional amount to the original loan; so you’ll have to go through the process of taking out a new loan for the excess amount.

Depending on the terms of your loan, you can pay higher interest rates if your credit is not excellent, making it more expensive for you to borrow money.

Also, pay careful attention to the details of your loan application; some have application fees, credit check fees, and late payment fees. Some loans also include pre-payment penalties if you pay off you loan early.

Photo Credit: stock photo

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