In 2022, $192 billion in consumer debt came from personal loans or online installment loans. This is a surprising $46 billion increase from just a year earlier.
The new average loan amount was $8,085. Sadly, these same loans carry a delinquency rate of up to 3.37%.
So, why are so many Americans seeking these installment loans? Is the delinquency rate connected to a lack of understanding of how the loans work?
Read on to learn more about online installment loans, how they work, and what it means when it’s time to pay the loan back.
An installment loan is a common type of lending for many different loans.
Installment loans are for the set amount you’re borrowing (the principal), which you must pay back over an agreed-upon period using monthly payments.
The monthly payment includes an amount towards the principal of the loan and an interest charge from the lender.
When you apply for any type of loan, you need to know the pros and cons of the loan. Most loans come with both positives and negatives.
When you sign up for an installment loan there are several advantages to this type of loan.
First, you’ll know the terms up front and you can get prepared for the same monthly payment over the course of the loan.
When you have the same monthly bill every month, it makes it easier to plan within your monthly budget. There won’t be a surprise each month as to what you owe, you can get prepared.
Handling an installment loan is a good way to improve your credit score. When you make your monthly payments over a period of time, it shows you’re a responsible borrower.
When you show that you’re a responsible borrower, not only with a credit score likely to improve, it may also open up opportunities to refinance your loan for better terms.
An installment loan often offers you the opportunity to make a large purchase you might not otherwise be able to afford.
If you have the opportunity to refinance your loan, you can either lower your monthly payment or shorten the term of the loan, or both.
There are also a few potential pitfalls to consider when seeking an installment loan.
First, the principal amount of the loan is fixed. Once you’re approved for the loan, you’ll get the money and start making payments. If you run into another financial crisis, you can’t increase the loan amount like you might be able to do with a line of credit, for example.
Loan payment schedules are often for long periods of time. That means you’re committing to those monthly payments for the life of the loan.
Some installment loans might allow you to pay them off early, while others will charge for an early payoff, since they would be losing some interest on the loan.
Conversely, paying off a loan early shows you to be a responsible borrower and would be good for your credit score and credit report.
If you miss payments over the course of the loan or are regularly late with payments, this can damage your credit. If you sought another loan later, this pattern of repayment would show up and cost you more for your next loan.
If you have average or poor credit, a personal loan will cost you more. In fact, often the interest rates for less than good credit on an installment loan are very expensive.
It’s important to remember that even if you opt to apply for a new loan if interest rates go down, each loan has an application and origination fees that get tacked onto the loan. You need to be sure the new loan is worth the additional fees it will cost you.
Now that you understand more about installment loans, it makes sense to understand the particulars of how your installment loan would be written.
Part of being a responsible borrower is the importance of understanding the terms of your loan.
Many people enter a bank or apply for a loan and feel intimidated. They’re afraid to ask if they don’t understand something because they don’t want to appear foolish.
Yet, if this is your loan with your name and credit attached to it, then you really need to understand what all the terminology means and how it impacts your installment loan.
Let’s take a closer look at the most common terms attached to lending an installment loan.
When you apply for an installment loan, the loan amount you seek is called the principal.
The principal is the amount borrowed, not to get confused with the amount you’ll pay back, which is larger than the principal.
If you need $10,000 to buy a car, the principal is $10,000. Of course, as you make your monthly payments over an extended period, you’ll pay much more than the actual $10,000 because of interest and fees.
Interest is the rate or amount the lender will charge you to borrow money from them. Interest is how banks and online lenders make their money.
It would be nice to imagine borrowing money to buy a home and dividing the principal by 360 equal payments. Your $200,000 mortgage would be impressively affordable.
But for the bank to afford to lend that $200,000, they also need to make money. So, each of your monthly payments includes the principal and the interest the lender charges.
Many loans, especially mortgages and auto loans, are set up, so you pay more interest upfront and lower principal.
As time goes by on the installment loan, that flips and the amount of the payment that goes towards the principal increases while the amount towards interest decreases.
One of the questions you’re likely to have as a borrower is how long you have to repay the loan you seek.
The amount of time you have to pay back a borrowed amount is called the term of the loan. Many mortgages, for example, are for 30 years. So, over 30 years, you make payments towards the loan principal and interest.
Many auto loans are for three, four, or five years. Over that period of time, you make payments. That’s the term of the loan.
One of the hardest things for a new borrower to understand is how much a loan actually costs versus what the amount is that you’re borrowing.
The APR, or annual percentage rate, more accurately shows what it will cost to take out an installment loan.
The APR is what a loan will cost over a year, and it includes payments toward the principal, interest, and any loan fees charged by the lender.
Most borrowers are surprised by how high the APR is compared to their actual principal amount.
Once you’re approved for your installment loan, you’ll have to begin making monthly payments for the loan term. These are installment payments that include the principal, interest, and any fees toward the loan balance.
If you make a payment late, you may get fees tacked onto the monthly payment.
Most monthly payments for installment loans are for the same amount each month over the life of the loan.
The exception might be if you have a variable interest rate. If the rate you pay for interest adjusts during the term of the loan, it could change the amount due for your monthly payment.
This should all be spelled out in the terms of your loan agreement.
A big part of your credit score is making payments on time. In fact, when the credit agencies calculate your credit score, 35% of the score is based on your payment history.
So before you sign up for an installment loan, it’s important to know you can afford that monthly payment. Take a closer look at your monthly budget and make sure you can swing by to make those monthly payments on time, so the loan doesn’t hurt your credit.
Another part of your credit score is when you apply for a loan. If the lender does a hard check on your credit, it can have some impact on your credit score.
If you’re loan shopping, make sure you do the applications close together. The credit agencies will typically group the credit checks from multiple lenders as one search.
Anytime you seek to borrow money, you need to understand the loan terms. An online installment loan is like going to a brick-and-mortar lender and will have loan terms for repayment.
If you’re interested in options for an installment loan, we can help. Contact us today to learn more about the loan options we have that might best fit your needs.