When are installment payments beneficial?

By Matthew San Giuliano on The Capital

(Image by Twopaddles from Unsplash)

If you’ve been shopping on eCommerce recently you’ve likely seen more companies offer check out options through third-party vendors. These third-party vendors offer installment payment plans to consumers and have been growing popularity. With the growing popularity of installment payments, it’s important to understand what they are, when to use them, and how they can be of benefit.

You’re likely familiar with installment payments but may not realize it. They’ve been around for a while, but only recently got dubbed their new name. Installment payments are when you pay for something over time instead of all at once. For example, if you’ve ever bought a car or new phone and made monthly payments instead of paying for it all upfront you’ve used a form of installment payments. Put simply, installment payments are breaking a large payment into several smaller scheduled payments to be made over time.

Recently installment payments have seen growth across major consumer goods sectors including home appliances, sports and outdoor, and luxury retail to name a few. Almost every major eCommerce retailer from Walmart to Louis Vuitton offers an installment payment option at checkout. With this comes an extremely competitive marketplace for installment payment providers. Some of the big names in installment payments include Klarna, Affirm, AfterPay, Splitit, Sezzle, and more. Each one with a unique value adds offering. Some of their benefits offered include no interest, no late fees, longer repayment periods, the ability to pay with credit, no credit history checks, and so on. Many of these offerings can be extremely valuable for consumers, but many of them can also be useless if installment payments are used improperly.

For instance, it may seem tempting to go and purchase extravagant items you otherwise would have never purchased because now you can get it at $263/month versus the $1500 all at once, and with no credit history check! But, this is exactly how NOT to use installment payments. You should instead only use installment payments when the following is true.

When to use:

1. It is an item you otherwise would have purchased anyway.
2. You are NOT going to be reliant on the money you are expecting to earn to make the payments.
3. You already have the money to pay for the item in its entirety.

A good example of when to use installment payments would be moving into a new apartment that needs to be furnished. You need a couch, coffee table, etc. You saved up and have enough to pay for the furniture in its entirety. But, even though the money may be available it can create cash flow challenges or higher than desired credit utilization. This is where installment payment providers come in and provide a segmented payment plan. Great solution, right? Not always. Many installment payment providers do this and charge interest, late fees, or don’t let you make payments with a credit card. In fact, many providers will only let you make payments coming directly from a bank account — which can take away most of the value installment payments have for savvy consumers because installment payments are most beneficial when there is no interest and they can be paid off using a credit card.

Here’s why:

1. It can lower credit utilization. It’s no secret that credit utilization is one of the five main factors that affect your credit score, and making a large purchase in one pay period could end up hurting your score. Even when you have the cash available to make a large purchase your credit limit may not reflect that available cash due to lack of history, income size, or other extraneous factors. You should not make the purchase anyway and risk hurting your score. Instead using an installment payment provider that allows for payments to be made via credit and has no interest you can keep a low credit utilization and make smaller payments over time. This will help maintain a strong credit score and allow you to have room for other purchases without exceeding your credit limit.
2. You can earn credit card benefits at a more comfortable pace. If you’re going to make a purchase of substantial size you should always get something back from it. Your credit card benefits are one of the main reasons you should use credit cards in the first place. And, while credit card rewards aren’t worth damaging your credit score by maxing out your limit, you also shouldn’t pay in cash and miss out on all the benefits. But, by using installment payments with no interest you can still get all the benefits of a $2000 purchase, but do it gradually over time without damaging your score. For example, if you were to purchase a new refrigerator and couch for $2000 using a Citi Double CashBack card that’s $40 in cashback. Seems small? Make that same purchase with a new American Express Green Card and it’s 45,000 reward points or $450 of free travel via the signup bonus. That’s potentially up to hundreds of dollars you’re leaving on the table if you pay in cash to avoid damaging your score. Using an installment payment plan you can still get the same benefits, but at a pace, that’s more comfortable for you. Making payments over the course of a few months rather than all at once.
3. It opens up cash flow. It’s no surprise that large purchases can make even the most financially secure person uncomfortable. It’s unsettling to see thousands of dollars leave your account at once regardless of if you have a strong emergency fund and financial stability. There’s always a piece of you that thinks well what if x,y, and z happen? Then what will I do? That’s why installment payments with no interest can be useful. They open up cash flow as the payment is broken out into smaller chunks allowing you to keep more cash on hand. Now to be crystal clear I’m not insinuating that the cash you’re able to hold onto for longer should be used as a safety net as well as be the money you’re putting towards an installment payment. You should always have a designated emergency fund and never make purchases contingent on expected income. But, in the event that something catastrophic happens this can be an extra layer of safety and at least buy you time to come up with the money you need rather than having spent it already. Again this is by no means a core benefit and only supplements the other two. It merely is an added layer of safety in the event something catastrophic happens.

To reiterate while installment payments can be beneficial they’re absolutely not a method to buy items you otherwise wouldn’t have or things you don’t have the money on hand to buy. That will lead to a damaged credit score, loads of interest payments, and late fees. Installment payments are instead a tool to help bolster your credit score, while still earning benefits, and maintaining strong cash flow. It’s important when considering an installment payment plan to make sure that the provider allows you to pay with a credit card and there is no interest on the payments. Otherwise, all these benefits go out the window and it essentially acts as a loan. Each provider is unique and these core benefits may not work with all of them. Many providers like Splitit and Sezzle do give you this option whereas others like AfterPay and Affirm do not. Always, read the terms of the agreement and understand what you’re getting into before electing for installment payments. If there’s no interest and you can pay with a credit card then, by all means, start preserving your cash flow and reaping benefits through installment payments.

The Capital