A Financing Guide To Installment Lending

By Michael Diaz. May 7th 2016

Have you ever needed to take out a loan that was so large that you could not repay it all at once? If so, then you are probably familiar with the concept of an installment loan. Mortgages, student loans and car loans are just a few of the many different forms of installment loans available to consumers. However, despite the number of different installment loans, there are two main characteristics that all installment loans share.

What Is An Installment Loan?

An installment loan is any loan that is repaid over a fixed period of time through a fixed number of intermittent payments. In most cases, the loan payments are of equal size and can be made daily, weekly, monthly, annually or biannually. Monthly payments are the most common basis for repayment. The term or length of the loan can also vary from a few days to 30 years or longer.

Popular Types Of Installment Loans

The following are the most common types of installment loans:

Typical Characteristics Of Installment Loans

There are two common characteristics that all installments loans share.

Interest Rate

The vast majority of installment loans have an interest rate attached to them. The interest rate will tell you how much it will cost you to take out the loan. If your installment loan has an interest rate attached to it, then you will have to make a periodic interest payment along with your repayment of the loan balance. Generally, the interest rate is a percentage of the principal amount of the loan that must be paid each year that the loan is outstanding. For example, if you take out a $10,000 installment loan with a 5 percent interest rate, your annual interest expense for the first year will be approximately $500.

Interest rates can be fixed or variable.

A fixed interest rate means that your interest rate will not change over the life of the loan. For example, if you take out a $10,000 loan with a 5 percent interest rate, you will pay 5 percent in interest until the loan is repaid. The benefit of a fixed rate loan is that you know exactly how much you will pay in interest over the life of the loan. The downside is that interest rates could fall and you will miss out on paying a lower interest rate unless you are able to refinance your loan to a lower rate.

A variable (also known as adjustable) interest rate means that your interest rate can and likely will fluctuate over the life of the loan. A variable interest rate is usually tied to an interest rate index that changes as a result of market conditions. For example, if you take out an installment loan with a variable interest rate, your interest rate might start at 5 percent, move to 10 percent one month and fall to 2 percent the next month. Changes in the rate will depend on the volatility of the rate index that the interest rate is tied to. The upside to variable rate loans is that it is possible that your interest rate falls which will lower your interest expense. The downside risk is that your interest rate could rise and you could end up having to pay larger than expected interest payments.

Some installment loans might not have any interest rate. This means that you simply have to repay the balance of the loan over the agreed upon term. Other installment loans might have no interest rate for a specified amount of time. For example, you might be able to take out an installment loan to purchase a television. The lender might give you a loan that has no interest during the first year of the loan. Therefore, if you pay off the loan before the beginning of the second year, you will not have to pay any interest on the loan.

Security

Installment loans can either be secured or unsecured. In order to get a secured loan, you must offer the lender an asset or assets as collateral. If you do not pay back the loan, then the lender will seize the collateral as repayment for the loan. The most common example of a secured installment loan is a mortgage loan. In order to get a mortgage loan, you will likely need to offer the house as collateral. If you fall behind on the loan, the lender can take possession of the house and sell it to repay the loan.

Unsecured loans are not secured by any assets. Student loans and most credit cards are common examples of unsecured loans. If you fail to make a loan payment, there is no asset or assets for the lender to seize in order to repay the loan.

Because secured loans offer collateral that the lender can sell to make up for missed loan payments, they generally have relatively lower interest rates than unsecured loans.

If you are thinking about taking out an installment loan, make sure that you fully understand the type of interest rate and the type of security associated with your loan. Keep in mind that in some cases, you might be able to select which type of interest rate and which type of security you want. In other cases you will not have a choice. Understanding these two characteristics will allow you to get an installment loan that is most appropriate for your financial situation.

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