Mortgages and car loans are the two most popular types of installment loans you can get today, but these are not the only types.
People generally take installment loans to buy something big or to consolidate their debts.
Are you interested in getting an installment loan? Are you wondering, “How do installment loans work?” Do you have questions about how an installment loan helps you build your credit?
If you wonder about these things, you’re in the right place.
This guide will explain what an installment loan is, how it works, and how it can help you build your credit.
What Is an Installment Loan?
An installment loan is a loan that has the following features:
- You borrow a specific amount of cash, which is the principal balance
- It has a stated interest rate, which can be fixed or variable
- It requires a specific number of equal payments
Installment loans always have these features, and you can get one for many reasons.
Many people take installment loans to buy cars, homes, RVs, or other expensive assets. Others take them to pay off debts they owe. Some people even take them to pay for a remodeling project, vacation, or costly event in life.
How Do Installment Loans Work?
Now that you know what an installment loan is, you should learn about how these loans work.
When you borrow money through an installment loan, the lender gives you an amount of money. This amount is the principal balance of the loan, which is the amount you must repay over time.
In addition to paying back the principal balance, you must also pay interest on the line of credit.
The lender will use the amount you are borrowing, the interest rate, and the number of payments to determine your payment amount. The payment amount is the amount you must pay monthly.
Every month you make your payment and your lender applies part of the payment to the interest you owe and the remainder to the principal balance. As a result, your principal balance decreases each month.
When you initially take the loan, you will pay more interest than you will as the loan works further towards maturity. This occurs because you pay interest on the balance. As the balance decreases, you pay less interest. Lenders call this amortization.
You can use an amortization loan calculator to determine how much your payments will be if you borrow money through a loan.
When you take an installment loan, your lender may even give you an amortization schedule that shows how they will divide your payments over the life of the loan.
How Do Installment Loans Affect Your Credit?
“Will an installment loan help my credit?” This question is one that many borrowers ask when evaluating their loan options. The answer is yes. Using an installment loan properly will help you build your credit.
How Installment Loans Work
How does this work? Well, it works in several ways.
In Canada, the credit scoring system uses numbers from 300 to 900 to represent a person’s creditworthiness. A score of 650 or higher is typically considered a good score. A score that is under 650 needs some work.
How Credit Scores Work
If you don’t know a lot about credit scores and how they work, you should learn a few basic features about them:
- A low score makes it harder to obtain credit lines, so you should always look for ways to increase your score
- Many factors affect your score including the age of credit, payment history, delinquent accounts, and credit mix
- It takes time to build and repair a credit score
How Installment Loans Build Credit
The good news about installment loans is that they help you build your credit score in several ways.
First, they provide a new type of account for your credit report. When you get the loan, it improves your credit mix and may increase your score. If you currently only have credit card accounts on your report, adding a new loan will make a difference.
Two, when you make your payments on the loan, you build a positive repayment history. The result is an increase in score over time.
Your score heavily relies on your payment history. If you have missed or late payments in the past, getting an installment loan gives you a chance to add positive details to your report.
Missed and late payments eventually fall off a report, but this process takes time. In most cases, it takes six years for this to happen.
Three, if you use it to pay off credit card debts, you improve your credit utilization rate. Your credit utilization rate compares the money you owe on credit lines to your credit limits.
If you have a credit line of $10,000 and owe $9,000, you have a 90% credit utilization rate. This rate is high and will negatively affect your credit. If you consolidate and pay this off, your rate would be 0%.
If you take an installment loan, you must follow one key principle: make every payment on time. If you follow this one rule, you will see an improvement in your credit score. If you break this rule, you will see a decrease in your score.
How Do You Get an Installment Loan?
So, how do installment loans work? Now you have the answers.
Getting an installment loan gives you a way to buy a costly item and pay for it over time. It also provides a way for you to consolidate debt or pay for something you don’t have the cash for right now.
If you would like to apply for one, give us a call or visit our website. We’d love to help you get approved for a loan you can use for any purpose.
