Everything You Need to Know About Installment Loans

When it comes to financing, your options are extensive. But one of the most popular types of financing is an installment loan. 

These loans are invaluable throughout most Americans’ lives — helping them pay for school, buy a home, get that car, and much more. 

So, what is an installment loan? How does an installment loan work? And what should you know before you apply for one yourself? 

What is an installment loan? 

An installment loan is a popular type of financing that pays you the entire amount borrowed upfront as a lump sum. You then repay that loan in a series of scheduled payments called installments. 

Typically, installment loans come with fixed interest rates. So, you’ll find that the payments you owe are the same amount each and every month. 

Installment loans come with predetermined term — the number of months or years it will take to repay. Once that term expires and all payments are made, the loan is closed. 

An installment loan differs significantly from revolving credit, another type of financing. If you have a credit card, home equity line of credit (HELOC), or personal line of credit, you already have a form of revolving credit. 

Unlike installment loans, which pay you a specified amount once, revolving credit offers open-ended access to an available pool of money. You can then withdraw variable amounts, as needed, up to the credit limit on that account. 

Types of installment loans 

Installment loans may be used for a variety of financial needs. Consequently, lenders offer types of installment loans that are tailor-made to specific situations: 

Mortgages 

A mortgage is an installment loan used to purchase or refinance a home. Second mortgages, also called home equity loans, are installment loans as well. 

With the most popular types of mortgages, homeowners borrow the funds necessary and repay in fixed monthly installments over a 15- or 30-year period. 

Auto loans 

An auto loan is an installment loan used to purchase a new or used car. In general, the term of your car loan will be two to seven years.  

Student loans 

Student loans are offered through both the federal government and private financial institutions. Often, parents or students borrow through these means to cover the cost of college, graduate school, or other advanced education. 

In most cases, the start date for repaying a student loan is delayed until the student graduates. 

Personal loans 

Personal loans are installment loans that can be used for nearly any purchase. Borrowers often seek a personal loan to pay for major repairs or renovations, consolidate debt, cover medical costs, or handle a big purchase. 

Bad credit loans 

Bad credit loans represent a specific type of personal loan. Most personal loans require a credit score of at least 670, effectively excluding people with fair credit, poor credit, or no credit. Bad credit loans through reputable financial institutions provide a solution — a financing option specifically designed for people with below-average credit scores. 

Secured vs. unsecured loans 

Installment loans can be either secured or unsecured. 

Secured loans 

A secured loan is backed (or “secured”) by some type of collateral. So, if you default on your debt, the lender can put a lien on that collateral. Lenders may even seize the collateral to sell in order to recoup their losses in lending to you. 

Mortgages and auto loans are generally secured installment loans. If you default on your mortgage, your lender may eventually foreclose on your home. And, if you repeatedly neglect payments on your car loan, the lender might repossess your car. 

Unsecured loans 

Unsecured loans are not backed by any collateral. Still, failure to pay comes with consequences. In certain circumstances a lender (or debt collector) can sue you for the amount owed. And the court, in some specific instances, may be able forcibly put a lien on your assets or garnish your wages. 

Student loans are unsecured, as are most credit cards and personal loans. In some cases though, you may find it easier to be approved for credit if you opt for a secured personal loan or secured credit card. 

Pros & cons of installment loans 

Like all forms of credit, installment loans come with their own advantages and disadvantages: 

Advantages of installment loans 

One of the most appealing features of an installment loan is its predictability. In general, your installment loans come with a fixed repayment schedule. So, you’ll pay the same amount on the same date each month until the term of your loan expires. 

As a result, you know upfront exactly when your loan ends and how much you’ll pay each month toward your debt. Having that information makes it easy to budget for your loan. 

Furthermore, installment loans offer a sound means of covering some of life’s biggest expenses — a new home, college tuition, house renovations, a car, and more. And you can use multiple loans over time to support your family’s goals. 

Disadvantages of installment loans 

Credit cards and lines of credit allow you to withdraw funds as often as needed. But installment loans offer a one-time transfusion of cash. So, if you find yourself needing more, you’ll need to apply for another loan or use revolving credit you already have. 

Unlike existing lines of credit, getting a new loan means going through the application process each and every time. You’ll have to fill out forms, supply documents, and wait for approval before the money arrives. 

And most loans come with fees. So, whenever you borrow money, you’ll likely cover the cost of a credit check and pay an origination fee, at a minimum. Some loans include a prepayment penalty, which charges you a fee for paying off your loan ahead of schedule. 

Ready to take out an installment loan? 

If you’re thinking of using an installment loan of any kind, you’ll want to avoid potential obstacles along the way. Follow these steps to worry-free financing: 

1. Choose the right type of financing. Is a loan really the right type of financing for you? Weigh your needs against the benefits of both loans and revolving forms of credit. 

2. Comparison shop. Not all installment loans are created equal. Before you commit, compare multiple lenders and the loan options offered through each. 

3. Prepare your credit. Generally speaking, you’ll have easier loan approval and better loan options if you have great credit. So, use the time before you apply to improve your credit history and credit score as much as you can. 

4. Get prequalified. Before you apply, go through the quick process of loan prequalification. You’ll get an estimate for what your lending options may be without any impact to your credit score. 

5. Submit your application. Once you’ve selected your loan, gather your documentation, fill out your forms, and submit your loan application! 

Odds are, you’ll have at least one installment loan during your lifetime. Understanding the basics of these loans can help you make smart choices about your financing options, so you can make the most of your money while pursuing your big financial goals.