Taking out an installment loan can be a great way to finance big projects or purchases and consolidate debt. Borrowing money, however, is a big financial decision. It is important to fully understand what an installment loan is by knowing all the risks versus rewards before taking out a personal loan.

PROS of installment loans

Fixed monthly payments and interest rates

Installment loans make budgeting easy since the core components of the payment will remain the same every month. The borrower is protected from a sudden increase in monthly payments if market interest rates rise. Fixed monthly payments also mean you'll be able to know exactly how much you'll spend over the lifetime of the loan and can compare your options accordingly.

Lower interest rates

Installment loans typically have lower interest rates and no hidden fees when compared with revolving credit loans, such as credit cards. Installment loans are often used to consolidate and/or refinance existing debt. That means you can use an installment loan to pay off your credit card entirely, and if your new loan has a lower interest rate, you can pay off your debt for less.

Help improve your credit score

Installment loans can improve your credit rating by adding on-time payment history to your credit report. They can also diversify your credit mix - your credit score factors in the different types of credit you have managed.

Make it possible to finance big purchases

Installment loans come in one lump sum, which grants borrowers immediate access to large purchases. Just be sure that over the course of time you'll be paying off your loan and that you have a reliable income to help you cover your monthly payments.

CONS of installment loans

Potential fees and penalties

Installment loan lenders may require the borrower to pay an up-front application fee or credit check fee. Penalties can also be assessed for missing a payment or paying the loan off early. Before you apply, be sure you're aware of how the application could impact your credit score, if at all. There are some lenders who offer pre-qualification checks that do not impact your credit score.

Credit-dependent interest rates

Installment loan interest rates and other terms will largely be based on the borrower's credit history. A borrower with a low credit score may not get a favorable interest rate and monthly payment amount for an installment loan when compared to other financing options. However, a low credit score doesn't necessarily mean no access to installment loans. Always feel free to check with a lender who allows you to see if you prequalify for a loan without impacting your credit score.

Fixed loan amount

Installment loans mean sticking to the payment schedule, in some cases borrowers cannot pay down the debt faster, as is the case with a credit card or revolving credit which can allow you to pay as little as nothing in interest if you pay off your balance in full.

Requirement of collateral. With secured installment loans, the borrower must name an asset as collateral. The borrower risks losing their asset if they default on payments.

The Bottom Line

Installment loans come with both potential risks and rewards and can be a good option for borrowers who have established a good credit rating. Understanding the pros and cons of an installment loan before borrowing money from an established lending company will help you make the right decision for your needs.

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