Key Takeaways
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Installment loans can include mortgages, car loans, personal loans and some types of home loans.
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The interest can be calculated at a fixed or variable rate.
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Some installment loans are unsecured, while others, such as mortgages, are backed by collateral.
Unlike credit cards, installment loans are a type of closed-end debt, meaning you can’t just borrow. Instead, you borrow a fixed amount at the start of the loan and pay it back over several years. Monthly payments go toward principal and interest.
Because of their structure, you may be able to borrow more than with a credit card, often at lower rates. This makes installment loans a good option for big expenses like paying for school, buying a car or even buying a house.
The 5 most common types of installment loans
Installment loans are one of the most common ways to finance life’s bigger expenses. Although they all work the same way, the most common installment loans have different features and interest rates.
Mortgages and car loans are the most common installment loans. Almost everyone will have one or the other in their lives, but you may also come across personal loans, student loans, and buy now, pay later loans. These are also popular – and often necessary – financing options.
1. Personal loans
Personal loans can be used for virtually any legitimate expense and are offered by banks, credit unions and online lenders. The best personal loan rates go to those with the highest credit scores.
Most personal loan lenders offer unsecured loans, meaning no collateral is required. As a result, personal loans typically have higher interest rates than secured options, such as mortgages or car loans.
Some of the most common uses for personal loans include:
- Contingency fees: Many lenders can fund loans the day after approval. This makes them a good alternative if you are faced with an unexpected medical bill or an urgent car or home repair.
- Debt Consolidation: A debt consolidation loan is a type of personal loan that lets you bring multiple lines of high-interest debt into one account with a fixed monthly payment. Getting a good interest rate on debt consolidation can also save you a lot in interest.
- Major purchases: While not recommended for every situation, major purchases and events such as vacations, weddings, and even home improvement projects can be financed with a personal loan.
There are many types of personal loans offered for almost any expense – from weddings to adoption costs to holiday-related purchases. Although most personal loan lenders place few restrictions on how the money can be used, not every lender or financial institution will offer loans for the same purpose. Make sure your needs are met before you sign on the dotted line.
For whom it is better
Personal loans are better suited for covering emergency expenses or high-return projects. Because of their flexibility, you can get a personal loan for anything from a medical bill to an expensive car repair or even a home renovation.
2. Car loans
Auto loans are specifically intended for the purchase of a vehicle. Although many dealers offer in-house financing, you can also find direct auto loans through credit unions, banks and online lenders. They typically offer lower rates and more repayment flexibility.
Before signing up, conduct a financial audit and create a repayment plan that fits your budget. Like personal loans, car loans typically offer fixed interest rates, but they are secured debts that use your vehicle as collateral. If you default on your loan, the bank has the legal authority to seize your vehicle to settle the overdue debt.
Like personal loans, car loans are available through banks, credit unions and online lenders. Rates vary widely and most lenders offer lower rates on new cars. You may also benefit from a shorter term. It may make your monthly payment higher, but a lower interest rate can offset the extra costs.
For whom it is better
Because they cover the cost of a new or used vehicle, car loans are a necessity for many people. If you don’t have the money to buy a car right away, you should probably check your car loan options.
3. Student loans
Student loans are used to finance a college education and related expenses such as books, supplies, housing, and food. Offered by the federal government and online lenders, 43.2 million borrowers currently have student loans in the country.
The Department of Education offers federal student loans through one streamlined application: the FAFSA. Federal loans are available to any borrower attending an eligible U.S. college or university, and they all have the same fixed interest rates. Because of the unique benefits and protections available to borrowers, it is best to look into federal lending first before considering private lenders.
Private student loans base your approval chances and interest rates on your creditworthiness, and it can be difficult to qualify for them as a student. Unlike federal student debt, private loans are serviced by a number of different lenders. Each company has different eligibility requirements and interest rates, so shop around to make sure you get the best student loan for your situation.
For whom it is better
After grants and scholarships, federal student loans are the best option for financing your secondary education. Private student loans should only be used if there are student costs that your federal loans cannot cover.
4. Mortgages
Mortgages are offered by a number of institutions, from national banks to credit unions and online lenders. There are five types of mortgages, including fixed and adjustable rate options, jumbo loans, government-insured mortgages and conventional loans.
Mortgages come in 15- and 30-year options. The 15-year option allows you to build equity and pay off the loan faster. A 30-year mortgage, on the other hand, gives your wallet some breathing room in the short term by charging a lower monthly payment.
Unlike other, smaller types of installment loans, mortgages have some of the most competitive interest rates. They also have the most variation in their structure. Depending on the mortgage type you qualify for, your home loan may have a fixed or variable interest rate.
Research your options carefully before choosing a lender. And if you already own a home, you may want to consider a mortgage loan or second mortgage to finance major expenses like college costs and renovations.
For whom it is better
Mortgages are another installment loan that many people will use during their lifetime. Because mortgages take different forms, you’ll need to do your research to determine which type of mortgage suits your home purchasing needs.
5. Buy now, pay later loans
Buy now, pay later (BNPL) loans divide the cost of a purchase into installments, usually four, so people can afford more than they otherwise could. Most retailers – especially online retailers – now offer some form of BNPL as a payment option.
With a positive repayment history, BNPL loans often do not charge interest or fees. They can be a convenient way to make purchases without incurring credit card debt, and they can be easier to get approved than for a traditional personal loan.
There are different types of BNPL loans. Some companies require a hard credit check, while others do not, and almost none report positive repayment habits to the credit bureaus. Another potential downside to these loans is that borrowers may be tempted to borrow more than they can afford.
Before making a large purchase, make sure you can make payments according to the BNPL lender’s schedule. This way you avoid costs and avoid putting too much strain on your finances.
For whom it is better
BNPL loans may be suitable if you need to cover essential expenses such as a piece of furniture. However, it may not be a wise financial move to use a BNPL loan for things that can be saved for.
Advantages and disadvantages of installment loans
Like any other form of financing, installment loans have pros and cons that you should consider before making a decision.
Installment loans typically have lower rates than credit cards and lines of credit. In addition, the interest rate can be fixed, making payments predictable and easy to calculate before you borrow. You can also see your credit score increase if you make payments on time.
The downside is that if you have less than perfect credit, you may be stuck with higher rates and more fees, especially if you don’t look for bad credit rates before you apply. If you have a variable-rate installment loan, you may also see your payments increase and the amount going to interest depending on market conditions. Finally, just as late or missed payments can positively impact your credit score, they can negatively impact your score for years to come.
Next steps
Once you’ve identified the type of installment loan that best suits your needs, the next step is to compare lenders and terms. This includes checking the lender’s eligibility requirements, comparing interest rates, fees and repayment terms.
Don’t rush into taking out a loan without thoroughly considering your options. Also remember to only borrow what you can afford to pay back. Keep in mind that while installment loans can be a great tool for managing larger expenses, they should not be used as a long-term solution to financial problems.
