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 are offering a different kind of installment loan that provides access to credit at a high cost.
Meant as an alternative to payday loans, these typically small, short-term installment loans come with a high annual percentage rate and are often marketed for emergencies or fast access to cash. Here's what you should know if you're considering one of these loans.
[Read: Best Bad Credit Loans.]
Alternative Installment Loans vs. Regular Personal Loans
High-cost installment loans for bad credit are no different from standard personal loans when it comes to their basic mechanics: Loan proceeds are paid to you, and you then pay back 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 with 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 falls into the 740 to 799 range, while a score of 800 or better 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 less. And because "traditional credit scoring loses predictive power at the sub-580 level," the approval process may be different, says Jeff Zhou, co-founder and CEO of Fig Loans, which offers installment loans to borrowers in Texas, Missouri and Illinois.
In that case, other financial factors may carry more weight. "Bad credit loans usually ask for some sort 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," Zhou says.
Pros and Cons of Alternative Installment Loans
While alternative installment loans give borrows access to funds they might not otherwise qualify for, there's an important downside: cost. Zhou says alternative installment loans may have significantly higher APRs and fees compared with conventional personal loans. Additionally, an alternative installment loan may have a low cap on how much you can borrow. Some high-cost installment loan lenders have maximum loan amounts as low as $2,500. There are, however, some installment loans available with higher loan maximums.
Zhou also cautions that not every alternative installment loan can be used to build credit. Whether your loan activity is reported to the credit bureaus depends on the lender. "This really hurts borrowers in the long run because it prevents them from being rewarded with access to lower-cost products when they make on-time payments," he says.
At the same, alternative installment loans can offer faster funding compared with other types of loans. "Unlike bank loans, installment loans from nonbank lenders typically get funded quickly, sometimes as soon as (the) same day for smaller loans," he says.
Jory McEachern, director of operations at credit repair service ScoreShuttle, offers simple advice: "Before signing any forms, do your research ahead of time and compare terms with different companies."
Using High-Cost Installment Loans Successfully
If you're contemplating an alternative installment loan, know that making your loan payments on time is the most important rule to follow.
Mike Sullivan, personal finance consultant with Phoenix-based nonprofit credit counseling and debt management agency Take Charge America, says, "Late payments trigger 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."
[Read: Best Home Equity Loans.]
Payment history accounts for 35 percent of your FICO credit score. An easy way to stay on top of your loan due dates is to enroll in automatic payments, if that's offered by the lender. Alternately, you can schedule automatic payments from your checking account to your loan each month.
Only borrowing what you truly need can keep loan payments manageable 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 overextending yourself, which could end up damaging your credit, instead of improving it.
Consider the Alternatives
An alternative installment loan is just one option for borrowers with bad credit. There are other paths that may be open to you when you need financing but have less-than-perfect credit.
Depending on your credit score, it may be possible to qualify for a regular personal loan, which could offer a longer term length than alternative installment loans. The caveat is that you may end up with a similarly high APR, owing to a low credit score. Zhou says people with bad credit could also consider a secured loan, which would require you to provide collateral. You might 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 about using credit," Sullivan says. "The focus of these consumers should be using cash while slowly and carefully rebuilding their credit."
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