You’re in a financial rough spot and you’re looking into taking out a loan to keep yourself afloat. You’ve heard about installment loans, but what is an installment loan? An installment loan is a loan where you borrow money from a lender and pay it back, plus interest, in roughly equal monthly payments. These loans can be good for your credit depending on who you borrow from.
Types of Installment Loans
All installment loans can be divided into just two categories. Secured loans and unsecured loans. Both of these have their benefits and drawbacks. Let’s check them out and see what might be best for your situation.
A loan is considered “secured” if it’s backed by some sort of collateral. For example, if you’re buying a car with a loan and you default on the loan, the company can take the car back. Some secured small-dollar loan companies will even take collateral like jewelry or a car title. They do this to make the loan less risky for them.
This makes it a bit riskier for borrowers because if they default on the loan, they lose their collateral. On the other hand, if borrowers make all their payments, they’ll enjoy a lower interest rate.
Secured loan lenders always check your credit score and they report your payment history to credit bureaus, so it does affect your credit score. So there’s another reason to make payments on time.
These loans are a good option if you qualify for them and will definitely make your payments. Secured loan interest rates are much lower and they boost your credit score if you make your payments.
Lenders who offer unsecured loans generally do not check credit scores. This makes them easier to get no matter your credit score, but the interest rates are much higher. The lender has no guarantee that they’ll get their money back, so they have you pay for the risk they take in interest.
Because they don’t check credit scores, it’s also difficult to tell whether the borrower will pay the loan back or not. All of this adds up to a loan that’s easy to qualify for but costs more in the form of interest.
Unsecured lenders that do check your credit score also report your payment record to major credit bureaus. This means that if your payments are made on time and in full, it will boost your credit score. On the other hand, if you miss payments, your credit takes a hit.
If you borrow from a lender that does not take credit score into account, missing payments or defaulting on a loan will not harm your credit score. Instead, they try to get their money back by taking legal action if necessary. So make your payments!
Credit Builder Loans:
Another option for building your credit is what’s called a credit builder loan (surprising, right?).
Credit builder loans are less common than traditional installment loans, but they have their time and place.
What’s a Credit Builder Loan?
Quick disclaimer, if you are in a bit of trouble and need some money now, a credit builder loan is not for you. This type of loan is just for building credit.
A credit builder loan may seem a little bit backward from a traditional loan. With a credit builder loan, you agree with a lender on the amount of the loan, and they deposit that amount into a bank account held by them. Then you begin making payments on the principal and interest of that loan.
Once you’ve paid the lender back in full, they give you the money that you’ve been paying for and they’ve been holding in an account.
What Does it do?
It may seem a little pointless to pay for a loan before you actually get the money, but there’s a reason for that. Because the lender holds the money while you’re paying it off, there’s very little risk for them. Because it’s not a risky investment for lenders, it’s typically very easy for borrowers to qualify for these loans.
These loans build credit by reporting your on-time payments to the major credit bureaus. As you make these payments, the credit bureaus will see that you are worthy of credit, and they’ll boost your credit score.
Not only do these types of loans help you build credit, but they help you build savings. If you look at it as putting money into a savings account instead of paying off a loan it makes sense. Once you pay off the loan, they give you the whole amount back. Just put this money into a savings account and you’ve got a nice emergency fund.
If you’re looking to get a quick and easy loan, and you don’t qualify for a secured loan, an unsecured loan is the way to go. If you have good credit and need money, go with a secured loan. Have bad credit and are just looking to build your credit history? Consider a credit builder loan.
If you’re just looking for more personal finance tips, check out more of our content here.