What is an Installment Loan?
If you’re interested in pursuing a this type of loan but want to better understand the typical rates, terms, and application process, keep reading to learn what an installment loan is and how it could help your business.
Installment Loan Definition:
An installment loan exists any time you borrow money from a lender in exchange for agreeing to make principal and interest payments over an agreed-upon period. This loan product contrasts with a revolving line of credit, which can be drawn down, up to a limit, or paid back at any time within the term. It is also different from payday loans, which are usually repaid in a single lump sum after your business receives customer payments.
In fact, funding options such as a mortgage loans, student loans, personal loans, and auto loans are all types of installment loans. Business loans can be installment loans as well.
How to Apply for an Installment Loan:
Since the term “installment loan” encapsulates so many different types of loans — from a short-term loan to a construction loan — the application process will vary. For example, while you could go pursue an online installment loan, complete a few forms, and be approved in just a few business days, applying for a construction loan may be far more complex.
Generally, you should expect to provide personal and business financial information when applying online or in-person for an installment loan. This will likely include a recent credit report, the amount of money your business earns each month, and other financial documents.
Lastly, you should have a clear plan for how you plan to use the loan and how you’ll pay off your balance.
Typical Installment Loan Qualifications:
While qualifications for different loans will vary considerably, lenders will generally evaluate you based on “The Five C’s,” which are:
To be approved for an installment loan, your lender must believe that you’re trustworthy and experienced enough to run your business effectively.
Lenders use collateral, such as real estate, to recoup their losses if the borrower is unable to make their daily, weekly, or monthly payments. While not every installment loan requires collateral, the value of your collateral (or lack thereof) will play a role in the lender’s decision to approve your application.
To be approved for an installment loan, your lender must have reason to believe you have the capacity to repay the loan. Often, this means that the lender will use the debt-to-income ratio to determine whether you have the capacity to make your payments.
If you have a significant amount of capital invested in your business, you’re likely to fight much harder than someone who has no money in the company to save the business. Lenders know this, so it’s important to them that a borrower has invested money into their own business.
Just as you analyzed the market conditions before starting a business, lenders will consider the state of the market before lending money. In fact, sometimes lenders will completely avoid lending to businesses in certain industries, regardless of any individual company’s financial health and reputation. Conditions can also vary by state, which is also something to consider.
In addition, conditions can affect the loan amount that you’re approved for, or the interest rates and terms that come with the approved amount.
Installment Loan Repayment Terms:
An installment loan is generally paid back in equal amounts over the lifetime of the loan. Due to this, there are usually fixed rates.
However, some installment loans will have interest-only periods or adjustable rates, in which your payments may change over the loan term. It’s also important to note that some installment loans may have prepayment penalties which makes it critical that you understand the specific terms and conditions of your loan.
How Installment Loans Affect Your Credit Scores:
Initially, when shopping for an installment loan, your credit score may take a small hit because prospective lenders may make a hard inquiry on your credit. However, if you make payments on time and in full over the long-term, an installment loan will help your credit score.
Still, remember that when you take out a loan, there’s always a risk — even if it’s small — of default or late payments which will negatively impact your credit score. Just like when you miss a credit card payment, not repaying your loan could hurt your business’s credit, which in turn affects your entire operations.
As the SBA points out, installment loans are one of the two basic kinds of loans, along with lines of credit. Yet within this loan category, there’s a large amount of variation when it comes to costs, loan limits, repayment terms, approval criteria, and other notable factors. However, understanding installment loans is the first step you should take before further exploring your business financing options.
Editor’s Note: This post was updated for accuracy and comprehensiveness in January 2021.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.