Key Takeaways
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An installment loan is a debt that gives you a lump sum of money and is paid off in monthly amounts, called installments, over a period of time.
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Installment loan payments usually include interest charges charged over the life of the loan and may be higher for borrowers with less than ideal credit.
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Each lender has different eligibility requirements and offers different installment loan products, so do your research and read the fine print before applying.
Installment loans allow you to borrow money and pay it back in equal monthly installments, usually at a fixed interest rate. They can be useful and versatile personal finance tools.
For example, you can use them for an important purpose or combine credit cards into one loan that you pay off in small, manageable chunks.
A well-known installment loan is the personal loan. Other examples of installment loans include student loans, mortgages and car loans.
What is an installment loan?
An installment loan is a type of closed-end debt. You pay it off in a certain number of months or years, also called your loan term.
Unlike credit cards or lines of credit, which are open-ended revolving credit, you cannot reuse the installment credit while paying off the balance. If you want to borrow additional money, you must apply for a new loan.
There are several common types of installment loans:
- Personal loans.
- Mortgages.
- Car loans.
- Student loans.
- Payday loans.
- Buy now, pay later loans.
To find these loans, go to institutions such as banks and credit unions, online lenders, mortgage brokers and dealers.
Installment loans can be secured or unsecured.
Secured installment loans
A secured loan requires a lien on an asset such as a house or car. If you are unable to repay the loan, the lender can use your asset as payment for the balance owed. Examples of secured loans are mortgages and car loans.
It may take longer to get secured installment loans. For example, the mortgage approval process takes an average of 40 days and involves a lot of paperwork. However, your approval may be less dependent on your credit score than with an unsecured installment loan.
Unsecured installment loans
Personal loans and buy now, pay later (BNPL) loans count as unsecured installment loans. These require no collateral. The approval process is simpler and usually based on your credit scores, income and debts.
Unsecured personal loans can be funded the same day you sign, and loan amounts are typically under $100,000.
Learn more: Where to get a $100,000 personal loan
How does an installment loan work?
Installment loans allow you to borrow an approved amount, which is paid out in a lump sum. They can be repaid over a period of time, ranging from a few weeks (for a BNPL personal loan) to 30 years (for mortgages).
These loans typically have a fixed interest rate and require regular monthly payments.
Part of each monthly payment goes toward the principal amount borrowed and another portion toward the interest on the loan. You continue to make loan payments for the life of the loan. The lender closes the account once the loan is paid in full, including principal and interest.
Are installment loans harmful to your credit?
Installment loans can damage your credit if you are late on payments or if you apply and undergo a hard credit check.
Try to choose personal loan providers that offer prequalification without a credit draw. When you formally apply, you will be hit hard, but the damage to your score should be small and temporary.
A late payment hurts your score more than a credit application, so make sure you keep your payment current.
To avoid damage to your payment history, consider setting up automatic payments so you don’t miss a due date.
However, certain types of installment loans may not affect your credit score. Buy now, pay later Financing typically does not require a credit check and payments may not be reported to credit bureaus. As such, they typically have no impact on your credit rating.
Should you get an installment loan?
An installment loan makes sense if you can afford the payment, are financially stable enough to pay it back, and can get some kind of financial benefit from it. Installment loans require a payment obligation that can last up to 30 years.
If you’re planning to change jobs or expect peaks and valleys in your income, an installment loan may not be your best option.
See whether an installment loan is suitable for your situation by comparing installment loan providers. Check out loan comparison sites to see offers side by side. If you are purchasing a home, you can contact a mortgage broker, who can consult with several lenders for the best programs.
Also make sure you compare quotes from at least three different companies to ensure you get the best price.
If you ultimately decide that an installment loan isn’t for you, explore alternatives to installment loans. Your options include personal lines of credit, credit cards, and home equity lines of credit.
The bottom line
Installment loans are a convenient option for consumers looking to cover major expenses, finance an unexpected financial emergency, consolidate high-interest debt, or buy a car or home.
But before you sign up, it’s crucial to understand how different types of installment loans work. It is equally important to shop around with different lenders to find a loan product with favorable terms that suits your financial situation.
