There are two main types of credit: closed-end (installment loans), and open-end (like credit cards). So what is an installment loan? It’s a simple enough concept – you borrow a set amount from a lender that you pay back (plus interest) incrementally over time, typically in monthly payments. So things like car loans, mortgages, personal loans, and student loans are considered installment loans.
Installment Loans Vs. Credit Cards
We already know that installment loans are usually a fixed amount that is taken out for one specific purpose, such as buying a car or a house. Credit cards are open-end (or revolving) credit that builds a balance as you use them and can be used over and over again.
Credit card payments often fluctuate month to month depending on the balance you’ve accumulated. The interest rates can also vary depending on whether you’ve had late payments, a drop in credit score, or reached the end of an introductory APR period. And while they do have credit limits, you can often receive an increase on that limit by being a good customer (always paying on time, maintaining a good credit score, etc.)
With installment loans, typically the payment is the same every month. You borrow a fixed amount, and if you want to borrow more, you often have to fill out another credit application. Also, the interest rates are typically fixed for the length of the loan.
Pros and Cons
There are positives and negatives to personal installment loans, just like most other things in life. It’s important to weigh all the factors to make the best decision for you. Some of the advantages are fixed interest rates, fixed monthly payments, and how great they can be for diversifying your credit. On the flip side, there’s also the possibility for extra fees and penalties, high interest rates, and the requirement of collateral.
How to Apply For An Installment Loan
Completing the application can typically be done online these days. After you submit it, the lender will review your credit score, your annual income, and your debt-to-income ratio. They use this ratio to determine how much you can reasonably afford to borrow. They may also ask you some additional questions about your employment, such as the name of your current employer and how long you’ve worked for them.
Your credit score is one of the most important parts of the application process, so you should keep a close eye on it several months before you plan on applying. Try to pay down any high credit card balances to improve your debt-to-income ratio.
A good place to start the loan process is with your personal bank or credit union. Since you already have a relationship developed with the lender and have checking and/or savings accounts with them, you might qualify for a discounted interest rate. There are also online lenders who offer installment loans.