Paying off installment loans in a timely fashion can help individuals build credit
Installment loans are money borrowed from a financial institution that the borrower agrees to pay back by way of a series of fixed payments. Those payments – called ‘installments’ – are typically made once a month. There are various means by which payments are made. Automatic deductions, payment by mail and in-person payments are all common. A traditional installment loan is not considered as a business loan. Nor do they have anything to do with predatory ‘payday’ loans.
Different Types of Installment Loans
There is more than one type of installment loan and each comes with its own set of terms and conditions. Here are a few of the most common types.
- Short Term Loans – Short term installment loans are useful for a variety of purposes including to pay for emergency medical treatment, car repairs, home repairs and more. Short term installment loans are typically less than $5,000 and are repaid over a period of months or perhaps as long as 3 years. When considering a short term loan, installment loan direct lenders like Western Shamrock are a good place to start.
- Personal Loans – This type of installment loan is often used to consolidate debt. A borrower may obtain a personal loan from a credit union, bank or other lending institution. Depending on the state of one’s credit, the interest rate on a personal loan may run as high as 36%. In some cases more. Therefore, it is crucial for the prospective borrower to shop around for the best rate rather than taking the first personal loan that is offered to them.
- Auto Loans – Virtually anyone who has ever purchased a car has had an auto loan. They are made by a variety of lenders. In some cases by the finance arm of the auto manufacturer itself. Car loan interest rates may be as high as 15% and often take as much as 6 years to repay.
Can an Installment Loan Really Help Me Build Credit?
The notion that installment loans can help you build credit is more than just a marketing ploy. However, simply being approved for an installment loan is not enough to enhance your creditworthiness. You will also need to:
- Make the Required Payments on Time – Future lenders will want to see that you have a history of making your loan payments on time. As such, there is no doubt that the most important factor influencing your credit score will be your payment history. In short, if you hope to build a solid credit rating, one that will open doors to lower-interest credit down the road, start by making the payments on your installment loan in a timely fashion.
- Establish a Diverse Credit History – People who have never had an installment loan of any kind and who rely only on credit cards are sometimes confused as to why their credit rating is not better than it is. They make their credit card payments on time every month, but still their credit rating languishes. This is most likely due to the fact that credit rating agencies want to see a diverse range of credit types on a person’s history. Adding an installment loan can provide this diversity.
- Reduce Your Credit Utilization – Credit rating agencies also like to see a low credit utilization ratio. As you may guess ‘low utilization’ means you are not using all the credit available to you. If you have credit cards that are maxed out, or close to it, paying them down with funds from an installment loan will reduce the utilization of those cards, expand the amount of credit available to you and make the rating agencies happy.
What are the Pros and Cons of Installment Loans?
Don’t apply for an installment loan without first considering the pros and cons.
Installment Loan Pros
- Simple Application – Installment loans, particularly short term installment loans, feature a simpler application process than a standard bank loan. Some lending institutions allow you to begin the application process online. Which saves time and hassle.
- Fewer Requirements – Short term installment loans typically present a lower eligibility bar to clear than standard bank loans. In some cases, all that’s needed is a valid ID, an address and proof of income.
- Timely Disbursement of Funds – It may take some time to get approval for a standard bank loan. Whereas with a short term installment loan you may get approval in one or two business days and have the money in your account shortly afterward.
- Predictability – Regardless of the type of installment loan, you know exactly when the payment is due and how much it’s going to be. There is no guesswork involved.
Installment Loan Cons
- Fixed Amounts – Once the installment loan has been approved there is no altering the amount. Should you realize after the fact that you actually need a bit more money, there is no way to increase the amount.
- Higher Interest Rates – Short term installment loans will sometimes feature higher interest rates than traditional bank loans. Always shop around for the best rates before signing on the dotted line.
The Bottom Line: Is an Installment Loan a Good Idea to Build Credit?
Unless you actually need funds for a particular purpose, it’s not normally a great idea to take out an installment loan simply to build credit. However, if you are facing unexpected medical bills, house or car repairs or some other type of emergency, applying for an installment loan instead of reaching for a credit card may be the wiser long-term choice.
An installment loan will allow you to diversify your credit portfolio, go on record as making all your payments in a timely fashion and get you the cash you need to transcend the immediate challenge. Whereas if you simply try to get through the immediate crisis by using your credit cards, you will increase your credit utilization, reduce your ability to use your credit cards in the future should the need arise and not do anything to expand your credit portfolio or enhance your credit rating.
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