Pros And Cons Of Installment Loans
Whether it is buying a car or a house, installment loans can help you get closer to your ideal lifestyle one step at a time.
You can pay off your loan through regular monthly payments that are based on your principal (amount borrowed) and interest rate. The number of installments varies from one loan to another.
Installment loans can be broken down into four general categories:
- Auto Loans – These loans are designed to help borrowers buy new or used vehicles. The vehicle is used as collateral that can be repossessed by the lender if you fail to pay on time.
- Mortgage Loans – This type of financing is designed to help borrowers purchase a home wherein the home is pledged as collateral for the loan.
- Personal Loans – For more general purposes, personal loans can help borrowers address needs like consolidating debt, expanding a home, financing a wedding or vacation, or other personal projects.
- Student Loans – Aimed at covering educational expenses, these loans help students pursuing a degree pay for tuition and other costs.
Each of these loans has its benefits and drawbacks. Knowing both will ensure that you select the appropriate loan to finance your needs instead of falling into a debt trap that is difficult to escape.
Advantages Of Installment Loans
The right loan can help you meet your financial objectives. With certain loans, you can even save on your tax liabilities. Read on to uncover the pros of a good installment loan.
Predictable
If you have worked out your equated monthly installment (EMI), you know when your next payment is due and for how much. This feature is important for the following reasons:
- By knowing your EMI, you can plan your monthly expenses accordingly
- By tracking your EMIs, you can predict when your loan would be completely repaid
- Predictability helps when arranging funds for your next purchase of a home or car
You can calculate your EMI with the following formula:
[P x R x (1+R)^N]/[(1+R)^N-1]
P is the total principal amount, R is the monthly rate of interest, and N is the number of monthly installments
Fixed Interest Rates
When you have a fixed interest rate, you can accurately predict your EMI. The above equation is applicable if the monthly rate of interest is constant for the whole loan period.
Still, for certain types of loans, the rate of interest is variable, meaning it can rise or fall. Depending upon the prevailing market conditions, your EMI could also fluctuate accordingly.
While easier to calculate EMI and budget with a fixed interest rate loan, variable rates can sometimes work to your advantage depending on conditions. Yet the opposite is also true for variable rate loans.
Loans with fixed interest rates are often more straightforward because the total cost is distributed evenly over the entire loan life.
Installment Loans Do Not Discriminate
Applying and receiving approval for a loan can be handled with minimal hassle. Even with a weaker credit score, you can still access a loan. While installment loans of bad credit borrowers generally feature higher interest rates, they are not inaccessible, even for those with less than perfect credit histories.
Disadvantages Of Installment Loans
Despite their attractive benefits, these loans are also accompanied by some disadvantages. If you are not careful, you might end up paying more on your loans than you expected.
Less Flexible
If you are paying fixed interest on your loan, you lose out on the potential advantages of variable interest rates.
- For example, if your monthly fixed rate is 0.06% while the market rate is 0.05%, you are paying above the prevailing rate.
- If the market rate is below your fixed rate, you will end up paying more for your loan than a variable rate.
- If you are paying a higher interest rate, then you may not be able to save and invest in fruitful ventures. This way, your loan bars your financial portfolio from growing.
The rigidity of installment loans extends to the payment cycle as well. You may run into trouble if you delay or forget payment dates.
Potential Predatory Traps
Be careful of the fine print and hidden penalties or fees that might accompany a loan agreement.
- Always check whether your interest is calculated on your total principal or on a reducing principal basis.
- Some lenders might not disclose the loan APR. This term refers to the additional charges that apply to your loan including mortgage insurance, closing costs, origination fees and more. APR is always higher than your interest rate, as it includes all costs associated with the loan. If you do not know your APR, you will end up paying more than what you anticipated when looking at interest rates alone.
- Be on the watch for prepayment penalties that might be assessed if you want to repay a loan early. Especially when applying for online mortgages, read up about potential penalties that can disincentivize early loan repayment.
Higher Rates And Increasing Interest
Your loan could affect your quality of life, impact your finances and creditworthiness if not properly managed.
- If you opt for a variable interest loan, you might be subject to higher interest rates at some point in time.
- If the loan duration is very long, you will end up paying your installment for many years, which could add up significantly in terms of interest paid.
- With a variable interest loan that has a very long duration, fluctuating rates might harm your ability to repay or add up to higher interest costs over the loan life.
Conclusion
To sum up, loans are great for helping meet your life goals when appropriately planned and executed. You may need a loan when considering a home purchase, planning a vacation, acquiring a new vehicle, and so forth.
Before applying for a loan, always read the fine print carefully. Identify your APR, loan terms and conditions, potential penalties if relevant, and determine how a loan will impact your monthly budget.
If you plan wisely and budget accordingly, you can anticipate your monthly expenses and make installment loans easier to manage. Moreover, you can also build up funds for reaching future financial goals.
