It’s no secret that there are many risky loans out there designed to trap borrowers in cycles of debt they’ll never escape.
Installment loans online are safer alternatives to predatory loans, but that doesn’t mean any instalment loan is right for you. There are important details you need to understand before you borrow. We talked to some of our favourite financial experts to bring you the top five questions to ask before you sign on that dotted line!
How long is the term?
When it comes to loans, your ability to actually pay it off is what really matters. To do that, you need to start with figuring out how much the loan will actually cost, and how long you have to pay it back.
Some loans, for example like North Cash, payday and title loans, require you pay off the whole thing in as little as two weeks or a month. And they’ll usually force you to do so in a single, lump-sum payment. That can be hard for most people to manage.
That’s why many folks turn to online instalment loans instead, which allow you to pay back the loan with regular payments over a longer period of time—usually anywhere from six months to three years. That’s why they’re called instalment loans: because you pay them off in instalments.
When applying for an instalment loan, ask how long you will have until the lender expects repayment in full (this is called the term of the loan). Once you know the term, then you can truly know how much the loan will cost you overall.
Understand the term before you sign the loan agreement. You don’t want any surprises down the line—once you’re already on the hook.
What are the interest rates?
Borrowing money isn’t free. Lenders make money on their loans by charging interest (the cost of borrowing money) to borrowers—that’s why it’s very important that the interest rate is one that you’ll be able to afford.
The quality of interest rates you’re likely to have access to will depend on your credit score. The lower (or worse) your credit score is, the higher the interest rates you can expect. Ideally, you will have built a good credit history before applying for a loan, but there are other options if your credit isn’t great.
Marc Johnston-Roche (@AnnuitiesHQ), co-founder of Annuities HQ, offers one method of getting a better interest rating: “There are lenders that accept co-signers. Some lenders allow borrowers with bad credit to add a co-signer with good credit. With a co-signer, you may get a lower rate or qualify for a loan that you couldn’t get on your own.”
It’s also important that you compare the cost of different loans using their APR, or annual percentage rate. This will show you the total cost of a loan including fees as well as interest, so you know exactly how much you’ll be paying.
Are there prepayment fees?
Because lenders make their money from interest, and borrowers pay more interest the longer their payment term is, lenders have an incentive to keep borrowers from paying off the loan sooner than they’re required to.
That’s why some lenders will charge borrowers prepayment penalties if they pay their loan off early.
Prepayment penalties are most often associated with mortgages—instalment loans that are taken out to purchase a house (and the house serves as collateral). If the homeowner is moving and wants to sell their home so that they can pay off the loan, they may be charged a prepayment penalty.
It’s important to know if your instalment lender charges prepayment penalties before you take out the loan since you’ll be obligated to uphold the terms of the deal once you’ve signed the contract.
The good news is that prepayment penalties are much less common than they used to be.
Per Randall Yates (@the_lenders_net), CEO and founder of The Lenders Network, “Prepayment penalties are very rare to see these days, in fact, they’re illegal for government-backed loans.”
He also adds that “Prepayment penalties are illegal on any loan in 14 U.S. states” and that “the other 36 states have drastically reduced the amount of loans issued with a prepayment penalty.”
Do I need to offer something as collateral?
Some instalment loans are “secured loans”—which means that the borrower has to offer up a valuable piece of property as collateral.
The great thing about secured loans is that they usually come with a lower interest rate. The not-so-great thing is that failing to pay the loan back means the lender can—and probably will—seize your collateral and sell it to make up their losses.
As mentioned above, one of the most common kinds of secured instalment loans is a home mortgage—where the home being purchased also serves as collateral for the loan used to purchase it.
The same is true with auto loans. You take out a loan to purchase a car—and the lender can repossess the car if you fail to make your payments.
But there’s another kind of loan that uses cars as collateral: title loans. These are high-cost loans secured using the title to a car that you already own—but could certainly lose if you fail to repay (read more in Title Loans: Risk, Rollover, and Repo).
Regardless of what type of instalment loan you’re looking for, it’s important to know if there is collateral involved, and under what conditions that collateral can be seized by the lender.
You never want to risk losing your car or your house.
Are payments amortized?
A proper instalment loan should offer amortized payments. That means each payment will go towards paying the interest and part of the principal, the original loan amount.
Without amortized payments, your payments could end up only going towards the interest—theoretically trapping you in debt forever!
Like we said at the beginning of the post: before you get a loan, you want to be sure you know exactly how much you’ll be paying and exactly how long you’ll be paying it for.
Instalment loans are a safer alternative to short-term payday loans, but they’re not all created equal. Ask the right questions and you’ll live to spend another day.