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If you are young and just starting out, you may not know much about financial products. Maybe you have taken out a payday loan here and there, but that’s about it.
Installment loans are generally a more serious loan product than a payday loan. They are typically for larger sums of money and they are repaid over a longer period of time than a payday loan.
In order to understand the loan contract, it’s important to understand the terminology. Let’s start with going over some of that.
How does an installment loan work?
This section will not be organized like a dictionary. Related terms will be grouped together and explained together rather than listed alphabetically.
The goal is to make sure you have some context to help you understand loan products and decide which one best suits your circumstances and needs. That takes a more organic process than dryly writing up definitions.
Secured Versus Unsecured Loans
Secured loans are loans given based in part on the fact that they are backed by something of value. This is an item the lender can take from you and sell for purposes of covering the loan.
The contract generally states that they can only take it and sell it if you default on the loan. In other words, if you fail to make payments on time and in full.
Some common examples of secured loans include new car loans, mortgages and pawning something at a pawn shop. If you buy a new car, the car can be repossessed if you fail to make payments.
If you buy a house, the house can be repossessed if you fall behind on your payments. A pawn shop will lend you money if you leave an item of value in their possession that they can sell if you don’t come back with the loan payment on time.
Unsecured loans are loans that are not backed by some item of tangible value. They are based on your ability and willingness to repay. If you default, there is nothing for the lender to sell to help cover their loss.
Generally speaking, secured loans are often for larger sums of money. They tend to have lower interest rates.
Unsecured loans are riskier for the lender than secured loans. Generally speaking, they will either want more profit in the form of higher interest and fees or more evidence that you are someone who will pay it all back in full and on time.
Personal Or Signature Loans
Personal loans or signature loans are just synonyms for unsecured loans. These terms basically all mean the same thing.
Generally speaking, when you take out such a loan, the money can be used for whatever you desire. In contrast, secured loans often specify what you can spend the money on, such as getting a car loan to buy a car or a mortgage to buy a house.
Collateral Or Security
When you take out a secured loan, the item that backs the loan is called collateral or security. So if you take out a car loan, the car is the collateral for the loan.
It may also be referred to as the security for the loan. Different contracts or lenders will use different terms. It can help to be familiar with all the different ways that lenders say basically the same thing.
Lump Sum Versus Installment Payments
Lump sum payment means you pay the entire loan amount in one large payment. Payday loans are typically lump sum loans.
You might borrow $100 and then have to pay back $118. The entire $118 is due in a single payment.
Installment payments are smaller increments spaced out over a longer period of time. For most loan products, installment payments occur once a month, but not always. Some loan products may have a different schedule, such as biweekly.
Installment loans are usually for larger amounts of money than a lump sum loan, like a payday loan. Paying it back in installments helps make the larger sum of money more manageable.
It’s a little like the saying “How do you eat an elephant? One bite at a time.”
A larger loan usually cannot realistically be paid off all at one time. It helps to take a bite out of the loan every month until it is eventually gone.
Technically, most car loans and even mortgages are installment loans. They are paid off in installments — a little at a time over a long period of time, usually with a monthly payment.
In practice, they are usually not called “installment loans.” In most cases, when a lender is talking about an “installment loan” they are talking about unsecured or personal installment loans.
Principal And Interest
Principal is the amount of money you are borrowing. Interest is the extra money you are paying back that lets the lender turn a profit.
In the aforementioned payday loan example where you borrow $100 and pay back $118, the $100 is the principal. The additional $18 is the interest.
It is important to understand the difference. When you pay the loan back, you will always need to pay the principal back in full, but the interest may be estimated based on the expected payment plan.
In practice, the actual interest paid may be different from the figures shown in the loan contract. For example, some mortgages use a variable interest rate. The interest being charged can change over time.
Also, if you have an unexpected windfall and decide to pay the loan off early, this may change how much interest you pay. You will still need to pay the principal in full.
When you have an installment loan, you will usually get a loan statement periodically. It should list the amount of principal still owed. This figure can be important for purposes of financial planning.
Prepayment penalties are a special charge that is incurred if you pay the loan off early. Generally speaking, it is better to get a loan that doesn’t have a prepayment penalty.
Avoiding a prepayment penalty clause helps to preserve your flexibility in the face of unexpected changes in your financial picture. Not having such a clause is a little like having a “get out of jail free” card.
If you happen to get a windfall, you are free to pay off the loan early, thereby drastically reducing the cost of the loan. It also will free up cash flow.
Personal Or Unsecured Installment Loans
If you have read this far, you should realize that personal or unsecured installment loans are typically medium-sized loans paid off a little at a time. You are probably borrowing more money than you would for a payday loan, but less money than you would for a new car or a house.
Payday loans tend to be emergency funds for an unexpected short-term financial event. This may be something like needing to see a doctor unexpectedly or minor car repairs.
But an installment loan is usually not for some minor emergency. It is usually for a medium-sized life event or personal transition.
What Can You Spend It On?
Because it is an unsecured personal loan, you are typically free to spend the money as you see fit. This can be very empowering.
With power comes responsibility. You need to make sure you spend such funds wisely.
Here are some things for which people sometimes use such funds:
- Career transition.
- School expenses.
- Life events.
It sometimes takes money to make money. If you have recently graduated from college, or expect to do so soon, you may be job hunting.
You may have worked fast food or retail jobs while in college. With a newly minted degree in hand, you may be applying for a serious professional position.
You may have nothing appropriate to wear. You may also need a more professional hairstyle. On top of that, you may find yourself incurring other minor expenses, such as printing costs for a polished resume on good quality paper.
Many firms will not consider hiring you if you don’t already look the part. No, they don’t want you to show up wearing what you wore while working retail. They will not give you the job and then hope you dress better once you have a better paycheck.
Instead, you may need to get a better wardrobe and haircut in order to have any hope of getting your foot in the door. This may mean borrowing the money to up your game and appear more polished.
If you go to a fully-accredited traditional college, you may have access to grants, scholarship and dedicated student loans. It may never cross your mind to take out an unsecured installment loan to help you cover school expenses.
But what if your dream job is doing professional massage or working as a bartender? You may find that the kind of schooling you need isn’t covered by traditional student loans, yet you still need funds to attend school.
This may also be a situation where an unsecured installment loan is the best solution for the problem. A short term course of study over the summer may only be a few thousand dollars and may promise better earnings immediately. It may make perfect sense to take out an installment loan to help you make this happen.
Whether you are getting married, moving to a new job in another city or having a baby, significant life events often demand funds now. The demand can be fairly sudden and unexpected, but it can be fine to pay it off over the course of a year or longer.
Although you don’t want to go too crazy and get yourself into financial trouble, it can make sense to borrow a few thousand dollars to cover a life event. Getting a marriage off to a good start or setting up a proper nursery for the new baby can be an investment in stable, happy family life.
Studies show that divorce is terribly expensive and people who stay married generally have better long-term financial outcomes. Studies also show that every extra dollar the state spends on preschool helps save more than a dollar down the line on programs for failed adults, such as prisons.
Living right is often the best way to protect your future finances. Counter-intuitively, this can mean investing some of your hard-earned money in your closest relationships.
A small lump sum now to help you bond with a new spouse or welcome a new child may help protect your financial future for years to come. So if that is what makes the most sense to you, don’t let other people convince it is a “frivolous” expense. Do what makes sense to you.
Healthcare installment loans
Investing in your health can also be an excellent investment in your future financial security. The most obvious example is that staying healthy so you can keep working can help protect your financial security.
Unfortunately, some expenses are simply not covered by a lot of health insurance policies. In some cases, doing something right can mean incurring out-of-pocket expenses on top of what the insurance company will pay.
One example: If you get cataract surgery, the surgery may be mostly covered by insurance, but getting corrective lenses as part of the process may be labeled “not medically necessary.” You may need to cover the difference out of pocket.
Such things can be frustrating because you only really get one shot to do it right. In some cases, the only thing that makes sense is to do your best to cover the difference between what your insurance deems “medically necessary” and the procedure that actually gets the optimal outcome.
An installment loan will involve more money than a payday loan. It is also a longer-term financial commitment.
A payday loan will be paid back in full in one lump sum payment in as little as a few days to as much as a month. An installment loan will be an ongoing commitment to making regular payments.
Crunch Some Numbers
As such, it takes a little more financial savvy and a little more financial planning. A good place to start is by playing with a loan calculator to get some idea of how much you can afford to borrow, as well as how different interest rates will impact that figure.
Yes, you read that correctly: The interest rate directly impacts how much you can afford to borrow.
A loan for $10,000 at 8 percent APR over 60 months will cost you $202.76 per month. At 7 percent APR, that same $10,000 loan over 60 months costs $198.01 per month.
If you can qualify for a lower interest rate, you may be able to take out a slightly larger loan. The interest rate can have a significant impact on how much loan costs and how much you can afford to borrow.
So take at least a few minutes to change the numbers in the calculator. Change the amount borrowed. Also, we recommend changing the interest rate. And change the length of the loan.
Seeing it with your own eyes is one of the best, painless educations you can give yourself. It is far better to play with a loan calculator than to learn the hard way what a loan mistake can cost you.
The Big Picture
When you take out an installment loan, you also need to consider what life will be like over the next few years as you make the necessary payments. Let’s use five years as an example.
Five years is long enough to get a college degree and change careers. It is a long enough time to give birth, raise the baby to school age and send the child off to school.
These can be very big life changes. What kind of life do you envision yourself having during the next few years while you make these payments?
Thinking about such things and asking such questions is part and parcel of trying to make a good loan decision. You need to have some general idea of where a long-term financial commitment fits into your life over the time frame in question.
Good Debts And Bad Debts
At one time, most of the world generally agreed that certain types of loan products were “good debts” and other types were “bad debts.” This standard wisdom has proven to be incorrect.
Examples of financial products once believed to be “good debts”
- Student loans.
- Business loans.
Examples of financial products once believed to be “bad debts”
- Payday loans.
- Signature loans.
- Consumer loans, such as for vacations or clothes.
If you ever read the news at all, you probably know that student loans have developed a very bad reputation in recent years. Many college students have developed an unhealthy borrowing relationship that has put their financial future in jeopardy.
Mortgages have also had their reputation tarnished. Eviction rates have been at record highs in recent years.
Even in cases where people weren’t evicted, many borrowers have ended up owing more than the house was really worth. It winds up being a painful situation that can keep people trapped in a house they cannot afford to sell. This can limit career options, among other things.
To be perfectly clear, you can’t count on a specific type of loan to automatically be a wise decision. So how do you tell what makes a loan good debt instead of bad debt?
Good debt is a loan that helps you solve a problem. It may help you save money or take advantage of a good opportunity. It may help you improve your earning capacity.
In order to really save money, the loan needs to cost you less than the amount you expect to save. So it doesn’t always make sense to borrow money to buy some item on sale.
However, it may make sense to borrow money to buy a big-ticket item that is being very steeply discounted. This can be especially true if you were intending to buy it anyway, even at regular price, and just happened to trip across a great deal.
Good debt is money borrowed to help you create a better future. It can take a bit of brainstorming to figure out which loans are good debts and which are not.
Read The Entire Contract
Another part of being fiscally responsible is understanding the agreement before signing on the dotted line. There are no shortcuts here. You actually have to read the loan agreement in its entirety.
It may help to review loan terminology before reading a loan agreement. This may help you better understand the contract.
It’s okay to take a little time. It can be a lot to digest. If you need a minute to process what you just read before reading more, that’s absolutely okay.
If necessary, ask questions or search online for any terms you don’t comfortably understand. Especially if you have never taken out a loan of this type before, there may be a lot of little details you need to work at understanding if you are going to actually understand the agreement.
It isn’t unusual for someone to take a payday loan with whatever payday loan place happens to be nearby. There may be no shopping around.
But if you are borrowing several hundred to a few thousand dollars and paying it back over the course of one to five years, you better shop around. This is a more long-term commitment and the stakes are generally higher for various reasons.
The more money you borrow, the more important it is to get the best interest rate you can reasonably find. If necessary, revisit the loan calculator and play with the numbers some to compare different loan products you are seeing.
If you have two different loan offers, don’t guess at which one has better terms. Crunch some numbers and get some hard figures to help you understand the real impact on your bottom line and cash flow situation.
Online Loan Matching Services
This is one of the merits of applying online through a loan matching service. It can let you fill out a single application and then see multiple loan products that may work for you.
Once it generates a list of potential matches, you can consider details like interest rates and loan amounts in evaluating which product makes the most sense for you. This can really save you a lot of money in the long run.
That’s what we do here. We help you find the right installment loan product for your needs and circumstances as conveniently as possible.
Why do I need to apply for an installment loan online?
Of course, you could go to a local bank or credit union, but applying online really offers a lot of advantages. In addition to being able to conveniently shop around, you have the ultimate in privacy and security.
You can apply from the comfort of home and may be able to get the funds directly deposited to your bank account within a day or two. If you don’t want anyone to know you are borrowing money, you can keep that completely confidential.
In contrast, if you go to apply for a loan in person, people may see you going in and be able to infer what is up. They may even rudely ask nosy questions.
In addition to being annoying, it can be a danger for other people to know the details of your personal business. Especially when that personal business involves money, people can all show up with their hand out as if they think you owe them a cut.
If they are friends, family or coworkers, this can be super problematic. Avoiding them may not be possible and it may make things awkward for a long time to come. This may be true whether you give them “their cut” or not.
How Much Can Or Should I Borrow?
There are myriad rules of thumb out there. This little section is intended to give you some general guidelines only.
For a healthy middle-class budget, it is generally recommended that your housing costs be no more than one third (33 percent) of your income. Lower is better and financially conservative individuals may try to keep it to one quarter (25 percent).
If you make $3000 per month in take-home pay after taxes, you should be able to spend up to $1000 per month on rent and other incidentals involved in having a home. Some people will count utilities in the $1000. Other people will not.
Many discussions of these ratios assume you are buying a house. They will suggest that one quarter to one-third figure is for a mortgage. But it works fine to think of it as for the costs of a rental.
But then things get a little more complicated because the next step is to recommend that your total debt payments be no more than either 36 percent or 40 percent of your income. This recommendation doesn’t quite parse if you are a renter.
No, you cannot pay $1000 in rent and also have up to 40 percent of your income go towards debt. The amount you are paying to cover housing costs needs to come out of that overall figure, even if you are renting.
So calculate 40 percent of your total income. If your take-home pay is $3000, then $3000 times .4 equals $1200.
Now subtract your housing costs from that figure to get the amount of debt you can afford to carry. If your rent is $1000, that leaves just $200 you can afford for servicing debt.
Obviously, if you are spending less on housing, you can afford to carry more debt. If you are spending more on housing, you can afford to carry less debt.
One of the best ways to stay out of financial trouble is to understand how much you can comfortably afford to borrow and stick to those limits. Don’t let easy credit get you in over your head.
It would be a great idea to do more reading on this area in specific. It is a key piece of financial literacy that is often given short shrift. The better you understand it, the more secure your financial future is likely to be.
By now, you should have some idea of how much money you want or need to borrow, how much you can afford to carry and what you would like to do with the money. The next step is to gather a few basic documents, such as a valid photo ID and a recent bank statement.
Personal loans don’t take a lot of paperwork. The application usually doesn’t take very long to fill out.
If you fill it out online, you may find out almost immediately if you have been approved. In many cases, it will be directly deposited to your bank account within a day or two. In some cases, it may even be deposited the same day.
If the terminology section of this page introduced you to a lot of new information, you might want to open another copy of this page in a new tab before you start your application. That way you can refer back to it if you get confused about anything.
Don’t forget you can also search for terminology when filling out an online loan application. There is no reason to not take the time to fully understand the entire application and loan contract.
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