Managing your personal finances can feel overwhelming — especially when you’re considering taking out an installment loan. Whether you’re looking to make a big purchase or cover an unexpected expense, if you don’t have all the details you may not be able to make the right financial choices for your situation.
Installment loans can be a helpful financial tool, but like all borrowing options there are some pros and cons. Let’s explore the benefits and drawbacks of installment loans and how they can impact you.
What Are the Pros and Cons of an Installment Loan?
Installment loans are a borrowing option that provides you with an upfront lump sum of cash that you can repay in “installments” over time. It’s one of the most popular types of personal loans and includes things such as:
- Auto loans
- Mortgage loans
- Student loans
Terms, loan amount and interest rate can vary depending on factors such as the lender, your credit score and the type of installment loan you need. Before deciding to borrow money, be sure to do your research.
Pros
Cover a large expense and pay it off over time.
An installment loan can help you finance a large purchase or cover an expensive emergency that may have otherwise been impossible to handle. For example, if you need to buy a new car, cover the price of a home repair or tackle an unexpected bill, an installment loan can be used to handle everything and allows you to pay it off over time.
Spreading out the repayment over months, or in some cases years, can help with your financial planning. Instead of being hit all at once, you can set aside a portion of your monthly budget toward the loan payment.
Get predictable payments.
Installment loans can offer you predictable weekly, bi-weekly or monthly payments (depending on your loan terms). Many installment loans come with fixed interest rates which means your payments will be the same, even if the market rates change. This can be helpful when budgeting.
Lines of credit and credit cards are a form of revolving credit, and often have variable interest rates. Because of the variable APRs and that people generally have different outstanding balances each pay period, the payments can look different on every due date. You might want to consider installment loan offers with a fixed rate if regular and consistent payments matter — making it simple to fold into your monthly budget.
It may help you build credit history.
If the lender reports to the credit bureaus and you make on-time payments, an installment loan can help you build your credit since your payment history makes up 35% of your FICO score. It can also help diversify your credit mix, which accounts for another 10% of your FICO score.
A good credit score can be helpful for many reasons, including getting better loan terms in the future. If you’re considering taking out an installment loan and you want to build your credit, check to see if your chosen lender reports to the credit bureaus and be sure to make all the payments on time.
The cost of borrowing may be lower than other options.
In comparison to other borrowing options such as payday loans, installment loans may come with a lower interest rate and easier repayment terms. This can help make repayment easier and save you money.
Installment loans can also offer more favorable terms such as no prepayment penalties, allowing you to repay the loan early to save on interest with no extra cost. This flexibility can also help reduce the cost of borrowing.
Cons
It can be a long-term commitment.
While installment loans can help you by spreading out the cost of a big purchase, you’re also committing to regular payments for the life of the loan. That means having an additional expense to work into your budget until the loan is paid off. However, as mentioned above depending on the terms of your loan, you may prepay the loan in full at any time during the life of the loan without penalty.
Paying down a loan means you have less money to spend on other things, and less money to put toward your savings goal. Before you decide to take out an installment loan, you may want to assess your financial situation and your long-term goals. Keep in mind things like job stability, income growth and other financial obligations to ensure that you can comfortably manage the loan.
The interest rates can be high.
While the interest rates for installment loans can be lower than other emergency borrowing options, they may still come with higher interest rates than other types of credit. This can increase the cost of borrowing and add additional strain on your finances.
In particular, installment loans designed for borrowers with bad credit can have high interest rates. If you’re considering taking an installment loan, be sure to review all the terms and conditions before signing a loan agreement.
It can be difficult to get more funds.
When you take out an installment loan you get all the funds upfront. This can be great for certain expenses, but it also means you could have limited access to additional funds. Unlike a line of credit, which offers you ongoing access to draw money, an installment loan only offers the initial sum.
Many financial institutions won’t allow you to take out more than one personal installment loan at the same time. If you run into challenges and need more money, you may need to refinance your loan. Before taking out an installment loan, be sure to assess your financial needs to make sure the loan amount will be enough.
There is a risk of debt.
Like any type of borrowing, installment loans can lead to an accumulation of debt. Getting out of debt isn’t easy, and when you have a lot it can be hard to meet all your financial obligations. This can lead to late payments and high interest charges, which may appear on your credit report and hurt your score.
Before getting an installment loan, it may be a good idea to assess your debt-to-income ratio and figure out if you can handle taking on debt. Create a realistic budget to determine the payment amounts you can manage.
How to Figure Out if an Installment Loan Is Right for You
Deciding whether an installment loan is right for you is a big choice. Here are a few things you may want to consider before making your decision.
Evaluate your current financial situation. Think about factors such as your income, monthly expenses and existing debts. This can help you make an informed decision about whether you can comfortably afford the payments.
Assess your long-term goals. Consider how an installment loan will affect your savings goals. Will you need to divert some dollars away from a goal to pay for the loan? In certain situations, it may be the right choice, but you should be aware of how the loan will affect your financial future.
Compare borrowing options. Explore alternatives before committing to an installment loan. You can look into other options like credit cards, lines of credit, or even asking a friend or family member for help with a loan agreement.
How to Choose the Right Installment Loan
If you’ve decided that an installment loan is right for you, you then need to pick the right installment loan. Here are a few things to keep in mind.
Shop around. You can compare loan offers and lenders to find the best rates and most favorable terms available to you. Make sure that the lender offers the type of loan you’re looking for and check to see if they report to the credit bureaus.
Read the fine print. Keep an eye out for things like unsecured versus secured loans, origination fees, credit checks, repayment periods, and any penalties. You should be aware of what’s required to apply and what you may be paying before you submit a loan application.
Consider customer service. Choosing a lender with excellent customer service and support can improve your borrowing experience. Look for a lender who is responsive to your questions and has a good reputation.
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