What Is an Installment Loan?

By | April 17, 2024

Installment loans are funds that you borrow and repay in equal parts over a set period of time. If your credit is less than perfect, an installment loan may be more affordable and pose less risk than other loans, such as payday loans.

How installment loans work

An installment loan is a fixed sum of money you receive from a lender which they expect you to pay back in equal portions at defined intervals, usually monthly or bi-weekly. These intervals are installments. Some common types of installment loans are home mortgages and auto loans. In some instances, installment loans can only be used for one specific purpose, while others can be used for anything.

Pros and cons of installment loans

Installment loans are usually manageable for borrowers as they boast predictable terms and can be refinanced if you can get a lower interest rate due to an improved credit score. Before you choose an installment loan, be sure to understand the pros and cons of this type of loan.

Pros:

  • Fixed payment amount is predictable
  • Can be used to purchase big-ticket items
  • You may be able to refinance your loan
  • Timely payments have a positive impact on your credit score

Cons:

  • You may be subject to loan origination fees
  • If you default on your loan, you could lose your collateral (for secured loans)
  • Repayment terms can last several years
  • Some installment loans impose penalties for early payback

What are the types of installment loans?

Installment loans can include car, mortgage, student, and personal loans.

  • Car loans. Loan for the purpose of financing a car purchase.
  • Mortgage. Loan to purchase a home.
  • Student loan. A loan designed to cover the costs of a post-secondary education, including tuition, books, room, and board.
  • Personal loan. Taken out by an individual to cover various needs, including a major purchase, a home renovation, or debt consolidation.

How installment loans affect your credit

By paying your loans and other bills on time, your creditworthiness can improve. Even if you faced credit issues in the past, you can still improve your credit score by making payments as agreed. Paying your debts promptly can also improve your access to credit.

Should you get an installment loan?

As noted, an installment loan can be used to fund purchases such as a home, car, education, or any other big purchase. As with any type of loan, there are pros and cons to weigh. The benefits may include lower interest rates than your credit cards and the opportunity to build your credit.

One disadvantage is that you are taking on debt, which means an additional monthly expense. Also, if you default on a loan that’s secured by your home or car, you could lose your collateral. And depending on the lender, some loans incur higher interest rates and origination fees.

How to apply for a personal installment loan

Most lenders consider the following factors when you apply for an installment loan:

  • Your credit score and report.
  • Your employment history.
  • Your income.
  • Any outstanding debts and obligations.
  • Amount and length of the loan.

Lenders will review the above criteria to make an approval decision and determine the interest rate and terms of your loan. Working with multiple lenders can help you compare your options and find the best loan terms for your situation.

Where to get an installment loan

Borrowers can apply for installment loans from banks, credit unions, and online lenders. They can apply in person or online. If you prefer a more traditional experience, consider working with a traditional bank or credit union. Popular online lenders include Upgrade, Upstart, and Discover.

Personal installment loans

A personal loan is an installment loan that may not be tied to a specific purpose, such as a mortgage or car loan. You could take out a personal loan for debt consolidation, home renovation, medical debts, or a motorcycle or boat purchase. Personal installment loans work the same as other installment loans, as you are borrowing a fixed amount and paying set installments on a predetermined schedule, but you can apply the funds for various uses.

Personal installment loans for bad credit

If you have bad credit, you may not be able to obtain a personal loan from a traditional lender, such as a bank or credit union, as these lenders often require borrowers to have a strong credit history. In that case, you may need to look to a company that offers bad credit loans. Examples include Avant, OneMain Financial, Best Egg, and LendingPoint.

Some lenders, such as Dave, Earnin, and MoneyLion, will even consider small loans without a credit check. If you deal with a bad credit lender, just be aware that you may be subject to a very high interest rate to account for the additional risk the lender is taking in granting the loan.

The dangers of high-cost installment loans

According to recent research released by the Center for Responsible Lending, the number of high-cost installment loans has increased over the past decade, often compounding borrowers’ financial problems.

Key findings from the research—which included quantitative and focus group data—show that:

  • Most borrowers refinanced their loans at least once. When coupled with the loans’ longer terms, this created a harmful long-term debt cycle similar to predatory payday loans.
  • Unaffordable interest and fees left borrowers unable to pay other bills.
  • Borrowers reported lowered credit scores and delays in wealth-building activities, such as home purchases, investing, and saving.

High interest rates on installment loans dramatically increase the borrower’s total costs. For example, a 200% APR on a $2,500 loan would cost the borrower $7,754 in interest and fees over two years without reducing the $2,500 principal balance.

Secured vs. unsecured installment loans

Unsecured installment loans are based solely on a borrower’s credit score, while secured loans are backed by some form of collateral to mitigate the risk incurred by a lender. Collateral can include cash, investments, a home, or vehicles, such as a car, boat, RV, or motorcycle. If a borrower has poor credit, a secured loan may be required.

Alternatives to installment loans

There are other ways to borrow money besides installment loans. Here are a few alternatives to consider.

Line of credit

A line of credit is a revolving credit loan. Instead of receiving funds upfront and making fixed payments over a specified period, the borrower is granted a credit limit. The borrower then decides if and when to draw money from the credit line and how much to draw. You don’t pay any interest if you don’t owe money on a line of credit. If you draw money from the credit line, interest will begin to accrue, and you must make a regular payment.

Some lines of credit are interest-only, meaning you are only obligated to pay monthly interest. However, in order to repay the line of credit, you will need also to pay down the principal over time. Lines of credit can be unsecured or secured by cash, a home, or other type of asset.

Credit cards

A credit card is similar to a line of credit in that it’s a revolving credit product with a predetermined credit limit. However, credit cards are designed for short-term borrowing, and have much higher interest rates on average than many installment loans and lines of credit.

Credit cards offer a convenient way to spend, as you have a physical card that can be used to make purchases wherever the card is accepted worldwide. Credit cards have a grace period, which enables you to avoid paying interest on a purchase as long as you pay your credit card balance in full prior to the due date. If you don’t, you will incur interest.

According to LendingTree’s internal data, the average annual percentage rate (APR) for new credit card offerings was 24.66% as of March 2024. If you have a strong credit score, you may lower your borrowing costs if you qualify for an introductory 0% APR credit card. This type of card provides an interest grace period for a specified time, but you must repay within that specified time.

Family members

If you’re unable to secure a line of credit or credit card or obtain a loan with a reasonable interest rate, it may be worthwhile to ask a close relative if they can lend you the money. Be sure to create a written contract and treat this loan just as if a traditional lender provided it. Borrowing money from family members or friends should be considered a last resort as any complications can strain your relationship.

TIME Stamp: An installment loan is ideal for financing important purchases, such as homes or autos

Installment loans are closed-end loans because the lender advances the funds upfront, and you pay the loan back in fixed amounts, known as installments, over a specific period. The amount and length of the loan can vary, but the loan payments are generally the same throughout the loan’s length.

Frequently asked questions (FAQs)

Are installment loans bad for credit?

Not necessarily. However, excessive debt of any kind can have a negative impact on your credit. Also, lenders report installment loans to credit agencies such as Experian, Equifax, and Transunion. If you do not make your loan payments on time—or even default on your loan—this information will be reported and can impact your credit score.

What is the difference between a personal loan and an installment loan?

In general, a personal loan is a type of installment loan. Personal loans can be utilized to consolidate debt, fund a big purchase, finance a new business, or cover sudden emergency expenses like car repairs, medical bills, or home repairs. Both personal and installment loans advance a lump sum you repay in scheduled, fixed installments.

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