There is an immense feeling of satisfaction in paying off an installment loan. It’s a weight off your shoulders. Gone are the interest payments and an entire line item from your monthly budget. But some lenders want you to delay repayment for as long as possible, and they work hard to make sure you do. Let’s take a look at how installment loans work and how to avoid paying more than you should.
First, we have to look at the structure of an installment loan. Probably the simplest type of loan, it is a temporary loan to be paid off in regular segments or installments. Most installment loans have a monthly payment schedule. If you borrowed $1,200 for a term of 12 months, you would pay $100 per month on the principal, or the amount of money borrowed.
Pretty simple, right? Well, if you’ve ever borrowed before, you’ll know that there’s another element. The lender doesn’t just hand out $1,200 and get $1,200 back. They would never earn a profit. Therefore, lenders charge interest, a percentage of the principal to be paid during each installment until the loan is satisfied, or “paid-off.”
Lenders count on interest to cover their operation costs. If you pay 10% interest each month over the course of this loan, and you pay it off on time, the lender has earned a $144 profit. But let’s say, six months into the loan, a family member gives you $600 to repay the remainder. You do, and the lender suddenly loses $72 in interest that it would have made. This is why many banks and other lenders charge prepayment penalties, fees for repaying your loan early.
Helix never charges a fee for early repayment of your loan. In fact, we encourage you to pay off your loan as quickly as possible, moving you one step closer to financial stability. We’re here to support you on your journey.
If you have the opportunity to repay your loan, take it. Not only will you save money on interest, but you can also begin to put that money every month toward savings. Helix loans are designed for emergencies and unexpected expenses. But if you can build your own emergency fund, you won’t have to take out a loan the next time you need money fast.
One of the major benefits of getting an installment loan from a lender like Helix is that it’s a great way to build your credit. Repay your loan on time and your credit score will begin to climb. But what if you repay your loan early? Will faster repayment impact your credit score?
The good news is that repaying your loan in a lump sum won’t hurt your credit score. The not so good news is that it won’t exactly help it either. According to Equifax, consistent, regular payments on a loan are more beneficial to your credit score than paying off a loan all at once, and an open account, into which you pay regularly, is more beneficial for your credit score than a closed account. Your on-time monthly loan payments help build a positive credit history.
A credit score is a measurement that future lenders can use to determine how good you will be at borrowing money. Remember, the loan industry profits from interest. So, if lenders determine that you will pay off every loan right after you take it, they won’t see you as a benefit to their business because it costs a lender time to arrange your loan. However, that doesn’t mean you shouldn’t repay early if you can. Remember, it can’t hurt your credit score. If you look at this from a cost perspective, you still have to pay that interest. If you have the opportunity to repay the loan in full and don’t take it, basically you’re buying a higher credit score with your interest payments.
This would be a solid strategy for a higher credit score if it was necessary, but it isn’t.
There are some other ways to build your credit, including credit cards. Credit cards can be a controversial topic, and rightly so. Going into 2020, U.S. credit card debt had risen to a new record: $1 trillion dollars. Many Americans live with several thousand dollars of credit card debt, making the minimum payments month to month, and racking up interest.
We don’t recommend this. However, if used responsibly, a credit card can be an excellent way to build credit. Unlike an installment loan, a type of term loan, a credit card offers a revolving loan. This is an open line of credit you can repay every month. This is the most responsible way to use a credit card— never charge more than you have on hand to pay off the balance.
The beauty here is that when you do repay your credit card balance every month, you don’t have to pay interest. And a credit card counts as an open account, even if you’ve repaid the balance. That reflects well on your credit score, and unlike the interest on an installment loan, it doesn’t cost you anything.
There are a couple of caveats here. Some credit cards have high annual fees, and that’s something to watch out for when you’re deciding which credit card to apply for. Yes, it’s a one-time fee every year, but it might be large enough to negate any money you would have saved on the installment loan’s interest.
The other thing to remember is that for a credit card to be an effective credit score booster, it needs to be used regularly. You don’t have to max it out every month, and you shouldn’t, but don’t let it atrophy. A good practice is to use your credit card for regular monthly costs, like your phone bill. That way you can consolidate those monthly budget items into a single item, and you still won’t forget to pay.
In summary, yes, if you have the right lender, you can pay off your installment loan early, and yes, we recommend it. It won’t hurt your credit score to do so, and there are many ways of building your credit that won’t cost you anything in monthly interest.
If you’re needing a personal loan, take a minute and fill out our simple loan application to see if Helix is the right lender for you.