Understanding consumer installment loans

Consumers obtain installment credit in two ways. With a cash loan, the borrower receives cash and then uses it to make purchases, pay off other loans, or make investments. With a purchase loan (also called sales credit), the consumer makes a purchase on credit with no cash transferring from the lender to the borrower. Instead, the funds go directly from the lender to the seller. For example, a car buyer might obtain a purchase loan from the General Motors Acceptance Corporation (GMAC) to buy a new Pontiac Grand Am. With some purchase loans, the lender is the seller. For all consumer loans, the borrower will sign a formal promissory note (a written installment loan contract) that spells out the terms of the loan.

Installment Loans Can Be Unsecured or Secured
Credit can either be unsecured or secured. An unsecured loan is granted solely based on the good credit character of the borrower. Sometimes unsecured loans are called signature loans because they are backed up by only the borrower’s signature. Because unsecured loans carry higher risk than secured debts, the interest rate charged on them is substantially higher.

A secured loan requires a cosigner or collateral. A cosigner agrees to pay the debt if the original borrower fails to do so. Being a cosigner is a major responsibility because a cosigner has the same legal obligations for repayment as the original borrower does. In case of default, a lender will go after the party either the borrower or the cosigner from whom it is more likely to collect the funds.

A loan secured with collateral means that the lender has a security interest in the property that is pledged as collateral. For example, the vehicle itself is the collateral on an automobile loan. The item of collateral does not necessarily need to be the property purchased with the loan. Typically, the lender records a lien in the county courthouse to make the security interest known to the public. A lien is a legal right to seize and dispose of (usually sell) property to obtain payment of a claim. When the loan is repaid, the lien will be removed. (The borrower should make sure this removal occurs.)

In the event that the borrower fails to repay the loan, the creditor can exercise the lien and seize the collateral through repossession, sometimes without notice. Almost all credit contracts contain an acceleration clause stating that after a specific number of payments are unpaid (often just one), the loan is considered in default and all remaining installments are due and payable upon demand of the creditor. These clauses protect the lender’s interest but can prove very difficult for borrowers. Don’t be fooled if you miss a payment and the lender does not exercise the acceleration clause immediately: It can do so at any time after default occurs. Do not ignore a warning letter from a creditor!

Purchase Loan Installment Contracts
Two kinds of contracts are used when purchasing goods with an installment loan:

•  Installment purchase agreements (also called collateral installment loans or chattel mortgage loans), in which the title of the property passes to the buyer when the contract is signed
• Conditional sales contracts (also known as financing leases), in which the title does not pass to the buyer until the last installment payment has been paid An installment purchase agreement provides a measure of protection for the borrower, as the creditor must follow all legal procedures required by state law when repossessing the property. Some state laws permit the lender to take secured property back as soon as the buyer falls behind in payments, possibly by seizing a car right from a person’s driveway.

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