Borrowing money is something most people have to do at least a few times in their life. There are many types of loans on the market, and knowing which loan type is best can be tricky. But most loans fall under one of two categories: installment or mortgage. It's important to note that all mortgages are installment loans, but not all installment loans are mortgages. Mortgage loans serve a specific purpose.
Installment Loan Definition
When it's time to buy a car, unless you've got thousands of dollars stashed away, you'll probably need a loan to make the purchase. In most cases, a car loan is a set amount over a set period of time. This is an example of an installment loan. A lender offers to give you a loan to buy the car, and you agree to repay it in installments for a certain period of time.
For example, your loan could be $350 a month for six years. Other examples of installment loans include personal loans for a vacation or to cover an unexpected expense, or financing that a department store might offer for larger purchases.
The interest rate is most often fixed so you'll pay the same amount each month until the loan is repaid. You might be required to provide collateral for the loan, which could be a trade-in of your old car for a new one or a cash down payment.
What Is a Conventional Mortgage?
A mortgage is a special type of installment loan that is primarily used for the purchase of a house. A mortgage installment loan operates in the same fashion as a regular installment loan, in that a lender will agree to loan you the amount requested in exchange for monthly payments until the loan is repaid. One exception is that a mortgage might have a variable interest rate instead of a fixed rate. Another difference is that a down payment of three to 20 percent of the home's purchase price is almost always required for a conventional mortgage.
Installment Loan Vs. Conventional Mortgage
A big pro to both installment and conventional mortgages is that they allow you to make purchases you might not otherwise be able to make. Even though the loan will cost more because of interest, being able to make large purchases faster is a definite positive. Also, so long as you stay current with the payments of your loan, you'll improve your credit score, and that can help with getting other loans, lower insurance rates and even help you land your dream job.
On the con side, you are locked into payment for the length of the loan. If your credit was blemished, your interest rate might be higher than desired, which means you will pay more for the convenience of getting the loan. If you miss payments and default on the loan, your credit report will take a huge hit and you might end up with collection fees and court costs. You could also lose the collateral you used to secure the loan along with the items you purchased with the loan. For instance, your car could be repossessed or your house foreclosed.
Choosing the Right Loan Type
Knowing which loan type is best depends on what is being purchased. You can get a personal loan to buy a house, but the interest rate on personal loans is generally higher than for a conventional mortgage, so you might pay more in interest. The installment period is also shorter, which means your principal payments will be higher as well.
In most cases, it is better to purchase a home with a mortgage and use installment loans for everything else. You can always consult with a lender at a local bank or credit union to see which option is best for you and your particular circumstances.
K.A. Francis has been a freelance and small business owner for 20 years. She has been writing about personal finance and budgeting since 2008. She taught Accounting, Management, Marketing and Business Law at WV Business College and Belmont College and holds a BA and an MAED in Education and Training.