Installment Loan Definition - What Is an Installment Loan & How Does It Work?
When you need financing for an upcoming purchase, your two main options are to apply for an installment loan or to use revolving credit, such as a credit card. Many people do not know the installment loan definition, and this makes it difficult to determine which financing solution is right for you.
With a closer look at the installment loan definition and how these loans work, you can better determine if you can take better control of your finances and use debt more advantageously.
Installment Loan Definition – What Is It?
A basic installment loan definition describes a loan that is repaid over a pre-determined period of time through regular payments, and these are usually equal monthly payments. The loan term could range in length from a few months to 30 years in most cases. At the end of the loan term, all of the debt is repaid. This is compared to a revolving credit option, which does not have a predetermined loan payoff date.
When you learn more about the installment loan definition, you can see that a critical benefit of this type of financing is the ability to pay outstanding debt off more easily. In comparison to a revolving term, an installment loan usually has a lower interest rate and more affordable payments.
Types of Installment Loans
- Unsecured installment loans;
- Student loans;
- Mortgage loans;
- Car loans.
Installment Loan Features
While the payments may be lower, the debt balance is usually eliminated much faster than with a revolving term debt. More than that, through the installment loan definition, you generally do not have to be concerned about taking on debt without having a strategic repayment plan in mind. This means that you can more confidently apply for this type of loan without significant financial concerns.
These loans can be secured by an asset, as is the case with a car loan or home loan. With a secured loan, the asset is used as collateral. If you default on the loan, the lender can seize the collateral to pay off your outstanding loan balance.
Installment loans can also be unsecured, such as with some types of personal loans. Because these loans do not use collateral, the lender may scrutinize your credit rating and the overall financial situation more carefully than if you apply for a secured loan.
Keep in mind that secured loans often have a longer term and a lower rate than unsecured installment loans. However, this can vary based on several factors, and it is wise to compare your options carefully before applying for new financing.
How Do Installment Loans Work?
Now that you have a solid understanding of the installment loan definition, you may be ready to learn more about how they work. These steps will walk you through the entire loan cycle for an installment loan.
#1. Applying for an Installment Loan
The first step to take when you want to apply for an installment loan is to determine which lender you want to work with and which loan program is right for you. Take the time to decide if an unsecured or secured loan is most well-suited for your needs.
Then, review different lenders’ loan program requirements, rates, and terms before you apply. Lenders’ reputations and financial strength should also be considered if you want to make a wise decision.
#2. Selecting a Loan Term
Pay close attention to the loan term before you finalize your installment loan application. The loan term can affect your monthly payment as well as your interest rate. Car loan terms may range from three to seven years or more in some cases, and home loans are usually 15, 20 or 30 years long. There are other variations based on the type of installment loan you apply for.
Generally, a longer term will yield a lower monthly payment. However, you will usually pay more in interest charges over the life of a loan with a longer term. Some online loan calculators can provide you with an easy way to analyze the options available to you.
You can typically apply for an installment loan over the Internet, but you may also be able to apply over the phone or in person at a local bank. Some installment loans, such as a car loan, only take a few hours or less to process and approve.
Home loans, on the other hand, may take several weeks to process and underwrite. In many cases, higher loan amounts come with more significant loan documentation and underwriting requirements.
#3. Making Regular Monthly Payments
After your loan closes, you will be required to begin making your installment payments very quickly. You should receive payment instructions when you sign the loan papers, including the amount and due date for your first scheduled payment. If you did not receive these instructions, monitor your mail for your first billing statement.
You can also contact your lender directly to obtain information about making your first loan payment. Remember that setting up automated payments will help you to avoid making late payments.
In some cases, you may be able to make more than the minimum monthly payment to pay the debt off more quickly. However, some installment loans have a prepayment penalty. The prepayment penalty may be a flat dollar amount or a percentage-based amount.
This type of penalty is most common with home loans, but it can be present with other types of installment loans as well. Review your loan documents carefully before prepaying any portion of the loan to avoid penalties.
Bottom Line
First, you need to understand the installment loan definition. Learn how this type of financing works. Then, you can make more educated decisions when applying for a loan. Credit cards and revolving loans may be well-suited for some purposes. However, applying for an installment loan is often advantageous in many cases.
If you have decided that you want to apply for an installment loan, spend time comparing the options. Also, review loan terms so that you make an educated decision about your finances.