Installment Loans — A Valid Alternative to Credit Cards
In an ideal world, people’s income would always greatly exceed their expenses, leaving them with a substantial savings account to handle any emergency expenditures. In real life, however, most Americans do not have savings that are sufficient to handle an unexpected financial crisis. If the refrigerator must be replaced, someone falls ill or the family car needs a costly repair, many people must take on a debt of some type to cover the expense. Although credit cards are popular for such emergency expenditures, an installment loan can be a better option.
Comparing Alternatives: Key Differences Between Installment Loans and Credit Cards
Credit cards are a type of revolving credit. The issuer assigns a credit limit to your account, and you can make purchases up to that limit. Your account balance subtracted from your credit limit equals your available credit. When you make payments, your account balance decreases, which increases your available credit. Theoretically, you could maintain a balance on a credit card for the rest of your life by simply continuing to make payments and new charges.
Installment loans, however, are a closed-end type of credit. You receive a one-time disbursement from the lender. You will make a pre-determined monthly payment for a specific number of months to pay off the loan in full. If you need additional funds, you must submit a form for a new installment loan.
What Are Some Examples of Installment Loans?
Many people have experience with installment loans without realizing it. According to USA.gov1, installment loans may be secured or unsecured. Secured installment loans include auto loans and mortgages; should the borrower fail to pay, the lender can take possession of the auto or property that was used as collateral to secure the loan. Unsecured installment loans do not require collateral. Student loans and personal loans are examples of unsecured installment loans.
Advantages of Choosing an Installment Loan Instead of a Credit Card
No two people have identical financial situations, so every individual should evaluate his or her circumstances to determine which option is best. However, although terms can vary by lender, installment loans typically offer the following benefits.
• The interest rate is usually fixed and lower than the interest rates on credit cards. Interest rates on credit cards can fluctuate, especially if you have a late payment or exceed your credit limit.
• Monthly payments on installment loans remain the same for the entire loan term or vary by only pennies. This allows predictable and accurate budgeting. Payments on credit cards are based on your balance, so they can vary a great deal from one month to the next.
• Installment loans make it more difficult for you to overspend. Your loan is for a set amount, and if you want to spend more than that amount, you will have to find another way to fund the extra expenditure. This can help prevent you from falling into a debt trap that is facilitated by revolving credit.
• Installment loans do not hurt your credit score as much as carrying a high balance on a credit card will hurt it. Revolving forms of credit are evaluated for credit utilization, which is the ratio of the account balance to the credit limit. According to Experian2, installment loans are not subject to the balance-to-limit ratio, but they are often included as part of the debt-to-income ratio that many lenders evaluate before approving a mortgage, auto loan or other credit product.
Some Experts Recommend Using an Installment Loan to Pay Credit Card Balances
In an era fraught with credit cards featuring variable interest rates, bonuses that are difficult to redeem and soaring interest rates, a growing number of financial advisers have recognized the benefits of installment loans. Many financial experts are recommending using installment loans instead of credit cards, and in certain situations, some experts are recommending that people even use installment loans to pay off their credit cards.
Experian3, for example, acknowledges that you might save money by using an installment loan to pay credit cards in full. The two factors you must consider are the length of time it would take to pay off each type of debt and the total amount you will pay during that time. To illustrate, suppose you have a balance of $900 on a credit card that has an interest rate of 25 percent. If you pay $100 per month and make no new charges, your total payments will be $1,007.08. An installment loan of $900 with an interest rate of 21 percent will cost $987.96 if you make payments of $100 per month. The greater the difference between the interest rates, the more your savings would be.
Is an Installment Loan Always Better than Using a Credit Card?
When you have a financial emergency, you may have many different options available to you. Only you can evaluate the choices properly to decide which option is best for your situation. Educating yourself on the different types of credit products available can help you make a better decision. You can learn more about installment loans by visiting PersonalMoneyStore.com4.