Installment loans, like personal loans, car loans, or mortgages, provide funds with a predictable repayment schedule. But for consumers with bad credit, some payday and online lenders offer another type of installment loan that provides access to credit at a high cost.
Designed as an alternative to payday loans, these typically small, short-term installment loans come with a high annual rate and are often marketed for emergencies or quick access to cash. Here’s what you need to know if you’re considering one of these loans.
Alternative Installment Loans to Regular Personal Loans
High-cost installment loans for bad credit are no different from standard personal loans in their basic mechanics: the loan proceeds are paid to you, and you then repay the loan according to the repayment schedule.
Where the two types of loans differ is in the approval requirements. To qualify for a regular personal loan from some lenders, you may need good or excellent credit. According to Experian, a good FICO credit score ranges from 670 to 739. A very good score is between 740 and 799, while a score of 800 or higher is exceptional. Some lenders offer personal loans to borrowers in the fair credit range, but interest rates may be higher and approval is not guaranteed.
Meanwhile, alternative installment loans, which are designed for those with bad credit, may require a minimum score of 580 or lower. And because “traditional credit scoring loses predictive power below 580,” the approval process may be different, says Jeff Zhou, co-founder and CEO of Fig Loans, which offers installment loans to borrowers. of Texas, Missouri and Illinois.
In this case, other financial factors may have more weight. “Loans for bad credit usually ask for some kind of income verification, like pay stubs or even copies of your utility bills to show that you have a history of making payments on time,” explains Zhou.
Advantages and disadvantages of alternative installment loans
While alternative installment loans allow borrowers to access funds they might not otherwise be entitled to, there is one significant downside: cost. Zhou says alternative installment loans can have significantly higher APRs and fees than conventional personal loans. Additionally, an alternative installment loan may have a low cap on the amount you can borrow. Some high-cost installment lenders have maximum loan amounts as low as $2,500. There are, however, installment loans available with higher loan limits.
Zhou also warns that not all alternative installment loans can be used to build credit. Whether your lending activity is reported to the credit bureaus depends on the lender. “This really hurts long-term borrowers because it prevents them from being rewarded with access to lower-cost products when they make payments on time,” he says.
At the same time, alternative installment loans can offer faster funding compared to other types of loans. “Unlike bank loans, installment loans from non-bank lenders are usually funded quickly, sometimes as early as (the) same day for small loans,” he says.
Jory McEachern, director of operations at credit repair service ScoreShuttle, offers simple advice: “Before signing any forms, do your research beforehand and compare terms with different companies.”
Successful use of high cost installment loans
If you’re considering another installment loan, paying off your loan on time is the most important rule to follow.
Mike Sullivan, personal finance consultant for Phoenix-based nonprofit credit counseling and debt management agency Take Charge America, says, “Late payments result in fees and, after 30 days, negative reports (go) to credit reporting agencies. An installment loan can help your credit, but only if paid on time.”
Payment history accounts for 35% of your FICO credit score. An easy way to meet your loan due dates is to sign up for automatic payments, if offered by the lender. Alternatively, you can schedule automatic payments from your checking account to your loan each month.
Only borrowing what you really need can manage loan repayments and minimize the amount of interest paid over the life of the loan. Sullivan advises limiting yourself to one high-cost installment loan at a time to avoid overstretching yourself, which could end up damaging your credit, not improving it.
Consider the alternatives
An alternative installment loan is only one option for borrowers with bad credit. There are other avenues that may be open to you when you need financing but your credit isn’t perfect.
Depending on your credit score, it may be possible to qualify for a regular personal loan, which may offer a longer term than other installment loans. The caveat is that you can end up with an equally high APR, due to a low credit score. Zhou says people with bad credit might also consider a secured loan, which would require you to provide collateral. You may be able to get a secured personal loan from your bank if you have a positive banking history.
Whether you choose an alternative installment loan or another bad credit borrowing option, commit to using it responsibly.
“People with poor credit should be very careful when using credit,” Sullivan says. “These consumers should focus on using cash while slowly and carefully rebuilding their credit.”