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An installment loan lets you borrow and pay back the same amount every month, usually at a fixed interest rate. Installment loans are a useful and versatile personal finance tool. For example, you can use an installment loan to achieve a larger goal, or consolidate your credit card payments into one loan to pay off in smaller, more manageable amounts.
A well-known type of installment loan is a personal loan. Other examples of installment loans include student loans, home loans, and car loans.
What is an Installment Loan?
An installment loan is a type of closed-end debt. You pay it back over a set number of months or years, also known as the loan term.
Unlike a credit card or line of credit, which is a revolving credit that never expires, you can’t reuse installment credit as you pay off your balance. If you want to borrow additional money, you’ll need to apply for a new loan.
Types of installment loans
There are several common types of installment loans.
- Personal Loans: A personal loan will provide funds for almost any legitimate purpose you need them for, unless specifically prohibited by the loan agreement. Typical expenses for which a personal loan is used include debt consolidation, emergency repairs, big-ticket purchases, and even weddings.
- Mortgage: A mortgage is used to purchase a home. It is also an installment loan, and the home you are purchasing serves as collateral for the loan. Mortgages can be obtained from banks, credit unions, and online lenders.
- Car loans: An auto loan is an installment loan designed specifically to finance the purchase of a car. It is available through car dealerships, banks, credit unions, and online lenders.
- Student Loans: Student loans provide funds to cover the costs associated with higher education. These loans can be obtained from private lenders or the federal government.
- Payday Loans: Payday loans are very short-term loans available for emergency situations. The interest rates on these loans are usually exorbitant. This type of lending provides funds to people who don’t qualify for other types of loans, so it usually targets borrowers with poor credit.
- Buy now, pay later loans: “Buy now, pay later” loans are typically offered by retailers and are intended to allow you to split the cost of a purchase into smaller installments. These loans usually have no interest or fees.
To find these loans, check with institutions such as banks, credit unions, online lenders, mortgage brokers, dealerships, etc. Installment loans can be secured or unsecured.
Secured vs. Unsecured Installment Loans
A secured loan is a loan that requires a security interest in an asset you own, such as your home or car. If you can’t repay the loan, the lender can seize the asset as payment for the outstanding balance. Examples of secured loans include home mortgages and car loans.
On the other hand, with an unsecured installment loan, you don’t have to offer any assets as collateral. The approval process is simpler and is usually based on your credit score, income, and debts, rather than on offering valuable assets to back the loan.
Personal loans and pay later (BNPL) loans are examples of unsecured installment loans. Neither of these require collateral. Unsecured personal loans can be funded as soon as the same day you sign, and loan amounts are usually less than $100,000.
How do installment loans work?
An installment loan allows you to borrow the approved amount in one lump sum, which you repay over a period of time – from a few weeks for products such as payday loans and BNPL plans to 30 years for products such as a mortgage.
These loans typically have a fixed interest rate and require regular payments, which can be weekly, biweekly, or monthly.
With a monthly installment loan, part of each payment goes towards the principal amount borrowed, and the rest goes towards the interest on the loan. You continue making payments on the loan for the life of the loan. When the full amount of the loan, including principal and interest, has been paid, the lender closes the account.
Do installment loans hurt your credit?
Installment loans can damage your credit if you make late payments or you are subject to a hard credit check when you apply. Be sure to choose a personal loan lender that offers pre-qualification with no credit check. Although you will be subject to a hard credit check when you formally apply, the damage to your score should be small and temporary.
Late payments hurt your score more than they do your credit report, so make sure you make your payments on time. Consider setting up autopay so you don’t miss any due dates to avoid damaging your payment history.
However, certain types of installment loans may not affect your credit score: Buy now, pay later loans don’t typically require a credit check and payments aren’t reported to credit bureaus, so they tend not to affect your credit score.
Should I take out an installment loan?
Installment loans are a good option if you have the ability to make payments, are financially stable enough to make the repayments, and get some sort of financial benefit. With an installment loan, you have a payment obligation for up to 30 years. If you plan on changing jobs or expect your income to fluctuate, an installment loan may not be the best option for you.
Compare multiple installment loan providers to see if an installment loan is right for your situation. Check out loan comparison sites to see offers side by side. If you’re buying a home, talking to a mortgage broker may help you find the best program from different lenders.
If you ultimately decide that installment loans aren’t right for you, consider alternatives to installment loans. Options include a personal line of credit, a credit card, or a home equity line of credit.
Conclusion
Installment loans are a convenient option for consumers who need help with large expenses, unexpected financial emergencies, consolidating high-interest debt, or buying a car or home.
But before you apply, it’s important to understand how the different types of installment loans work. It’s equally important to compare different lenders to find a loan product with favorable terms that suit your financial situation.
