What is an installment loan?
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UPDATED: May 15, 2013
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An installment loan is a long-term loan, usually due in small installments spread out over several weeks.
Under an installment loan, the lender gives the borrower a certain amount of credit. Unlike payday loans, which usually need to be repaid within 14-31 days, an installment loan is paid out in monthly installments over the course of several months.
To avoid the interest rate caps set in place by several states, installment lenders employ two tactics: offering loan insurance packages and convincing borrowers to renew their loans.
The insurance premiums charged by installment loan lenders usually pay for death and disability insurance. These premiums protect the lender more than the borrower. If the borrower dies or becomes disabled before they are able to repay the loan, then the lender will still be paid through the insurance policy. If the borrower offers their car as collateral for the loan they may also be offered auto insurance.
By charging borrowers insurance premiums, and charging interest on those premiums, installment loan lenders circumvent state interest rate caps. Reports show that in states with higher interest rate caps, installment loan lenders are less likely to sell these largely unnecessary insurance policies.
Borrowers are also given the option to renew, or refinance, their loan. After the borrower has made a few payments on their loan they can “cash out” and receive whatever potions of their payments that went towards the loan principle. The loan then resets itself and the borrower begins the entire lending process again.
What if I don’t pay my installment loan?
Installment loan lenders can be very aggressive when it comes to retrieving payments. Some installment loan lenders use a combination of phone calls and home and office visits. Certain lenders have also been known to contact the references a borrower lists on their loan, sometimes up to 2 or 3 times a day.
If these methods don’t work a lender may resort to garnishing a borrower’s wages.
Is an installment loan a good idea?
Like other high-interest loans, installment loans have steep pros and even steeper cons. For borrowers with poor credit, who would be unable to get a loan from a traditional lender, an installment loan may seem like the best option. And because installment loans can be paid over time, they offer more flexibility than short-term payday loans.
However, installment loans usually end up costing borrowers more than they bargained for. Between high interest rates, unnecessary insurance policies and fees incurred from drawing out a loan, installment loans are capable of trapping consumers in ongoing cycles of debt.
While emergencies can’t always be planned for, would-be borrowers should diligently monitor their finances to create an emergency fund, thereby reducing the need for high-interest loans.
In a statement to loans.org, Scott Pooch of SW Pooch & Company, LLC, wrote, “you might need to sell some things, to get an extra part time job, to eat Ramen Noodles for a while – whatever it takes to get back in control of your money.”
By carefully managing their finances, borrowers will be better able to break the habits that lead to debt, Pooch said.
“Track every penny you spend for a few months and ask yourself after each expenditure ‘here is where this money went, is that ok?’ Pooch said. “Have a respected friend (one with some financial sophistication) to share this with and who will act as an accountability coach.”