Installment credit allows you to borrow a set amount of money that will be repaid over a fixed number of equal payments, known as installments.
Installment credit basics
Installment credit, or an installment loan, simply speaking, is a loan that you make fixed payments toward over a predetermined period of time. Each fixed payment is known as an “installment.”
This type of credit will include some sort of interest rate, as well as specific repayment terms and fees over the course of the repayment period. Typically, installment loans are paid back in monthly payments.
These loans allow you to borrow a fixed amount of money and follow a fixed schedule to pay back the loan. There are some pros and cons to installment lines of credit, understanding the basics and how they can affect your credit report is important.
Types of installment loans
Many of the most commonly thought of loans are actually installment debts, or installment loans. Installment loans include mortgages, personal loans, student loans and auto loans.
- Mortgages – Mortgage loans are used to buy a home. Mortgages are long term loans, often lasting for 20 to 30 years.
- Personal loans – Personal loans can be used for almost anything. They often have higher interest rates than other types of installment loans because your loan is not backed by collateral.
- Auto loans – As the name suggests, auto loans are used to buy a car. They are typically 36 to 72 months long, but longer loan terms are offered by some financial institutions.
Comparing installment credit to revolving credit
Revolving credit and installment credit are very different types of credit accounts. A revolving credit account can carry a balance from month to month, whereas installment credit cannot.
Things like credit cards and other similar loans are examples of revolving credit. On these types of accounts, you have a certain credit limit on them, meaning that you can only “borrow” a certain amount each month. However, this amount is determined by you.
You are in control of your monthly payment amounts. But, if you do not pay off the balance in full each month, high interest rates are charged. Minimum monthly payments are also enforced. Continuous late payments or missed payments will make your credit score suffer.
Will installment loans help me build credit?
Installment loans are a great way to build and improve your credit history, therefore improving your credit score over time. Because a strong repayment history is one of the largest factors used to determine your credit score, making consistent on-time payments will show your lender that you use credit responsibly.
The fixed monthly payment will also help you budget for the payment each month so you never miss or default on a payment. However, paying off these loans early will likely not have a huge impact on your scores.
Checking your credit score often can help you see the changes over time as you use your installment loan to build up your credit.
Once an installment loan is paid off in full, the loan will be closed. Closed accounts in good standing can benefit your score for the next 10 years.
Installment loan benefits
Installment loans are extremely predictable, especially if they also have fixed interest rates. This means that each month your payments will likely remain the same, if not the exact same amount from month to month.
The predictable nature of these loans makes they much easier to budget for than revolving lines of credit. They also have a consistent repayment schedule, making them easy to plan for so you never miss a payment.
Their strict loan terms also give you comfort that your loan will be paid off by a specific date. Although these loans are not flexible in repayment, their consistency helps you determine exactly how large of a loan you can afford. When applying for installment loans, ensure that your monthly payment will not stretch your budget too thin.
The drawbacks
The main drawback to installment loans is that they are very inflexible. Once you take out the loan, you cannot add more money onto the loan amount. If you need more money, you must, instead, take out another loan to borrow the money. You must understand how much you need to borrow before shopping around for a loan.
In addition, your credit history is what determines your interest rate. For example, if your credit score is low or if you have a bad history with credit, you will be stuck with a very high interest rate, especially when compared to those with a stronger credit report.
Installment loans can also come with additional fees and penalties, including application fees, credit check fees and other hidden fees that will increase the cost of your loan. Some will even charge prepayment penalties if you pay the loan off early.
Wrap-Up
Installment loans can help you reach your financial goals, such as buying a house or buying a vehicle. They allow you to pay back large purchases over a long period of time. In addition, installment loans can help you build your credit and improve your credit score. At Cambio, we can help you with rebuilding your credit score. Click here to learn more
