An installment loan is a type of loan where you borrow a lump sum of money upfront and repay it over time in fixed payments, or installments. Unlike revolving credit like credit cards, installment loans provide you with access to funds all at once rather than allowing you to draw down incrementally on a credit line.
Installment loans can be a useful way to finance major expenses like a home, car, or education. They allow you to break up a large cost into more manageable monthly payments over a set repayment term.
Below, we’ll explore how installment loans work, the different types available, their pros and cons, and more.
How Do Installment Loans Work?
With an installment loan, you’ll receive the full loan amount upfront as a lump sum. This lump sum is deposited into your bank account by the lender.
You’ll then repay the loan in fixed monthly installments over a set period of time, typically ranging from 6 months to 30 years, depending on the type of installment loan. Each monthly payment goes towards both the principal (the amount borrowed) and interest.
As you make payments over time, the principal balance decreases while a portion of interest accumulates each month on the outstanding principal amount. This continues until the loan is fully paid off at the end of the loan term.
Most installment loans have fixed interest rates and fixed monthly payments. This helps provide stability in knowing exactly what your payment will be each month. Variable rate installment loans with fluctuating payments also exist, but are less common.
You can use this installment loan calculator to estimate monthly payments based on the loan details like amount borrowed, interest rate, and repayment term.
Types of Installment Loans
There are many types of installment loan products available to suit different borrowing needs. While all installment loans provide access to a lump sum upfront and are repaid monthly, the specifics, like loan amounts, interest rates, terms, and qualifications, can vary significantly.
Below are some of the most common types of installment loans.
Personal Loans
A personal loan is an installment loan product offered by banks, credit unions, online lenders, and other financial institutions.
With a personal loan, you can typically borrow between $1,000 and $100,000. The repayment term ranges from 1 to 7 years generally. Interest rates on personal loans can range from around 5% up to 36% depending on your creditworthiness.
Personal loans are one of the most flexible types of installment loans. You can use the funds for almost anything – debt consolidation, home improvements, medical bills, vacations, and more. They are also typically unsecured, meaning you don’t have to put up an asset like your home or car as collateral.
Those with bad credit can still potentially qualify for a personal loan, but will pay higher interest rates. Lenders like Upgrade, Upstart, and Avant cater to borrowers with fair credit or lower. Those with good credit can find the lowest rates from lenders like Lightstream and SoFi.
Auto Loans
An auto loan is a type of installment loan used specifically to finance the purchase of a new or used car. Auto loans are secured by the car itself. The lender can repossess your car if you fall behind on payments.
Auto loans typically range from $5,000 to $50,000 for new cars and $5,000 to $30,000 for used cars. You’ll repay the loan over 2 to 6 years, generally. Interest rates on auto loans range from 3% to 20%, depending on your credit score and other factors.
You can get pre-approved for an auto loan before visiting the dealership, which gives you bargaining power to negotiate the best deal. Auto loans are available from banks, credit unions, and auto manufacturers. Third-party online lenders like myAutoloan also provide competitive auto loan offers.
Mortgages
A mortgage loan is used by homebuyers to finance real estate purchases. With a mortgage, you’ll borrow a large lump sum upfront to cover the home purchase price minus any down payment you put down.
Mortgages are secured loans since the home itself serves as collateral. They typically range from $50,000 to over $1 million. You’ll repay the mortgage over 15 to 30 years through monthly installments. Interest rates are from 3% to 7% for qualified borrowers.
Mortgages come in a variety of forms, including fixed-rate, adjustable-rate, FHA, VA, and jumbo loans. Work with a reputable lender like Quicken Loans or LoanDepot when financing a home purchase.
Student Loans
Student loans are a specific type of installment loan designed for financing higher education costs. They provide access to a lump sum to cover tuition, room and board, books, and other college expenses.
You’ll repay your student loans in fixed monthly installments over 10 to 30 years, typically. Interest rates on federal student loans are set by Congress and fixed. Private student loans have variable rates based on the lender and your creditworthiness, typically ranging from 3% to 13%.
Both federal and private student loan options exist. Federal loans like Direct Subsidized and Direct Unsubsidized loans from the Department of Education are best for most students because of flexible repayment options. Those needing additional funds can supplement with private loans.
Buy Now, Pay Later Loans
Buy now, pay later (BNPL) loans have emerged as a new form of short-term installment financing. BNPL plans let you split a purchase into fixed installment payments over a period of weeks or months.
For example, you might split a $200 purchase into 4 interest-free payments of $50 every two weeks. BNPL loans are useful for budgeting bigger purchases without racking up credit card debt or interest. Providers like Affirm, Afterpay, and Klarna offer BNPL at major retailers online.
Benefits of Installment Loans
Installment loans provide several advantages as a financing option. Here are some of the key benefits.
- Predictable payments – With fixed monthly payments, installment loans allow you to reliably budget for the repayment. This helps prevent unexpected fluctuations that can throw your finances off track.
- Lower interest costs – Installment loans tend to have lower interest rates than credit cards and lines of credit, especially when you have good credit. Less interest paid means more savings.
- Improve credit – Making on-time payments can help build your credit history and scores over time. This helps qualify you for better loan terms in the future.
- Consolidate debt – You can consolidate multiple debts into a single installment loan. This simplifies repayment to one monthly payment at potentially a lower interest rate.
- Access lump sums – Installment loans provide funds upfront in a lump sum, which can be useful to cover large expenses, make purchases, or consolidate debts.
- Flexible terms – You can tailor the loan amount and repayment duration to fit your budget and needs through different installment loan options.
Drawbacks of Installment Loans
While installment loans have benefits, there are also some potential drawbacks to consider:
- Long repayment terms – While stretching out payments is helpful, it also results in paying more interest costs over the life of the loan. A 30-year mortgage accrues significantly more interest than a 5-year personal loan.
- Prepayment penalties – Some installment loans charge fees if you pay off your loan early. Make sure to review the loan agreement for any prepayment clauses.
- Missed payment fees – A late payment on an installment loan can lead to late fees, increased interest rates, and credit damage. autopay or reminders can help avoid this.
- Collateral risks – Defaulting on a secured installment loan like a mortgage or auto loan means your home or car collateral can be seized.
- Difficult to increase – If you need access to more financing later on, you’ll have to apply for a new loan rather than draw more funds, like with a HELOC or credit card.
- Qualification hurdles – Installment loans often have more stringent eligibility requirements compared to revolving credit. You may need a certain credit score or debt-to-income ratio.
Overall, installment loans give reliable access to lump sum financing that can be paid off over time in predictable installments. But the lengthy commitment, strict terms, and collateral risks require serious consideration.
What Credit Score Do You Need for an Installment Loan?
The minimum credit score requirements for an installment loan will vary depending on the lender and loan type.
For unsecured loans like personal loans, the minimum credit score is often around 580 to 620. Those with scores in this range will pay higher interest rates. Applicants with very good credit in the 670–740 range can qualify for the lowest rates on personal loans.
Mortgages and auto loans require higher minimum scores, typically 620 and 660, respectively. Borrowers need excellent credit exceeding 740 to qualify for the lowest mortgage and auto loan rates.
Some lenders may allow co-signers with better credit to overcome low credit scores. Secured installment loans backed by collateral also require lower scores.
Those with poor credit below 580 may have difficulty qualifying with major lenders. Subprime lenders offer installment loans to borrowers in this range, but at exceedingly high interest rates. Improving your credit or waiting until your score increases over time is recommended.
How an Installment Loan Affects Your Credit
Applying for an installment loan can impact your credit in a few ways:
- Credit checks – Most lenders will perform a hard credit inquiry when you apply for an installment loan. Hard inquiries can knock a few points off your credit scores temporarily.
- Lower credit mix – Closing an installment loan account will reduce your mix of credit types, which can negatively impact scores.
- Payment history – Making on-time installment loan payments builds positive payment history. However, missed payments hurt your credit.
- Lower utilization – An installment loan consolidates balances into a fixed payment account. This drops your credit utilization compared to maxing out cards.
- Credit age – Installment loans add new accounts to your credit history, lowering your average account age. But keeping accounts open long term offsets this.
Overall, responsibly managing installment loans can strengthen your credit standing over time much more than it hurts. Pay on time, keep accounts open after paying off loans, and limit applications.
How to Qualify for an Installment Loan
You’ll need to meet certain requirements to qualify for approval for an installment loan. Here are some key criteria lenders evaluate:
- Credit score – Your credit score is one of the main factors in loan approval decisions and dictates the interest rate offered. Good credit earns better rates.
- Income – Documented income, typically through paystubs or tax returns, proves you earn enough monthly to afford the loan payments. Higher and stable income improves your odds.
- Debts – Lenders review your existing debts, including credit cards, other loans, alimony, rent, and utilities. Too much existing debt reduces approval chances.
- Collateral – For secured installment loans, the asset pledged as collateral must be enough to cover the loan value in a default.
- Down payment – A 20% or higher down payment on mortgages and auto loans shows you’ve committed personal funds and lowers default risk.
Pre-qualifying or getting pre-approved gives you an early indication of what installment loan offers you may qualify for. Having all your financial documents ready speeds up the formal application process later on.
Getting an Installment Loan with Bad Credit
Those with bad credit scores below 629 may have a harder time securing an affordable installment loan with reasonable rates from mainstream lenders.
But options are still available. Here are some tips for getting an installment loan with bad credit:
- Work on improving your credit first through on-time payments, lowering balances, resolving errors on your credit reports, etc.
- Consider a secured installment loan using an asset like your car as collateral to offset the lender’s risk.
- Apply for a co-signer with better credit to potentially use their qualifications for approval and better rates.
- Comparison shop subprime installment loan lenders that work with lower credit borrowers, but watch out for very high rates or predatory terms.
- Reduce requested loan amounts to increase affordability given your credit profile.
- Provide documentation explaining past credit issues demonstrating you’ve moved beyond those struggles.
With some effort, those with less-than-perfect credit can still find installment loans to fit their budget and repayment capability at reasonable rates.
Alternatives to Installment Loans
Installment loans aren’t your only option for financing. Depending on your borrowing needs, consider these other alternatives:
Credit cards – Credit cards provide revolving credit lines you can access as needed. Useful if you need flexibility, but can lead to overspending.
Personal lines of credit – A line of credit offers access to funds you can draw on then repay over time. Lower rates than credit cards but less flexibility.
Payday alternative loans – Offered by credit unions as small, short-term loans with low rates for members.
Home equity loans – Tap your home equity via loans or lines of credit and deduct the interest on taxes. But risk foreclosure if you can’t repay.
Private lenders – Borrow from companies that provide financing for specific expenses like medical procedures or fertility treatments.
Buy now, pay later plans – No interest installment plans from companies like Affirm and Afterpay let you split payments on purchases.
Personal loans from friends/family – Borrow informally from people you know. Be sure to draft a loan contract detailing terms and repayment schedule.
Compare all options, including installment loans, to pick the one optimal for your budget and financial situation. An installment loan makes sense for large, long-term financing needs where structured payments are beneficial.
Pros and Cons of Installment Loans
Weighing the advantages and disadvantages helps determine if an installment loan is the right choice for you.
Pros
- Predictable, fixed monthly payments
- Potentially lower interest costs than revolving credit
- Easier to qualify than personal lines of credit
- Allows access to lump sums for major purchases
- On-time payments can improve credit scores
Cons
- Missed payments hurt credit and may incur fees
- Early repayment may trigger prepayment penalties
- Long terms means more interest paid over time
- Limits flexibility in increasing loan amount later
- Difficult to qualify without good credit history
Installment loans make sense when you need significant financing that can be repaid through scheduled monthly payments over years. But carefully consider the lengthy commitment required.
How to Get an Installment Loan
If an installment loan seems right for your borrowing needs, here are the main steps to getting one:
- Check your credit – Review your credit reports and scores so you know where you stand before applying. Reports are free weekly through 2023 at AnnualCreditReport.com.
- Compare loan options – Research different installment loan types and lenders to find the best loan, rate and terms for your situation.
- Pre-qualify – Many lenders allow pre-qualification, which lets you see potential offers by submitting limited information without a hard credit check.
- Gather documents – Have pay stubs, tax returns, and bank statements ready for the formal application to verify income, employment, assets, debts owed, and more.
- Apply for loan – Submit the full application with necessary documents for underwriting. Be sure to read the fine print so you understand the loan details.
- Accept loan offer – If approved, evaluate the loan offer thoroughly before signing the agreement accepting the installment loan.
- Receive funds – Once finalized, the installment loan funds will be deposited into your specified bank account, usually within a week of signing.
Be sure to compare multiple installment loan offers to find the optimal one for your borrowing needs and financial situation.
Conclusion
Installment loans allow borrowers to finance major expenses, purchases, and investments with a lump sum of financing that is repaid over set periods in predictable installments. This structure helps manage payments but also comes with long repayment terms and strict qualification criteria.
Comparing multiple installment loan offers and evaluating pros and cons allows you to determine if this financing route aligns with your financial situation. Installment loans serve a specific role in lending that open-ended revolving credit cannot always fulfill.
For large financial goals you want to methodically chip away at over years, installment loans can provide affordable, structured repayment. But carefully weigh the options and long-term commitment required before moving forward with an installment loan.
Frequently Asked Questions About Installment Loans
What is an installment loan?
An installment loan provides a lump sum of financing upfront that you repay in equal monthly installments over a set period of time, usually several years. Installment loans can be secured by collateral or unsecured.
How does an installment loan work?
You receive the full loan amount borrowed upfront in a lump sum. You’ll then make fixed monthly payments, including principal and interest, until the loan is fully repaid at the end of the loan term.
What are the different types of installment loans?
Some of the main types of installment loans include:
- Personal loans – General unsecured installment loans for various uses.
- Mortgages – Secured installment loans used to purchase real estate.
- Auto loans – Secured installment loans used to purchase vehicles.
- Student loans – Unsecured installment loans for higher education costs.
- Buy now, pay later loans – Short-term installment loans for online purchases.
What is an installment loan vs a revolving loan?
Installment loans provide the full amount borrowed upfront in a lump sum that you repay in installments over fixed periods. Revolving loans, like credit cards, give you access to a line of credit that you can draw on and pay back on a variable schedule.
Are installment loans secured or unsecured?
Installment loans may be secured or unsecured. Secured installment loans use an asset, like a house or car, as collateral. Unsecured installment loans have no collateral tied to them.
What credit score do you need for an installment loan?
Requirements vary by lender, but you typically need a credit score of at least 620 for personal loans, 660 for auto loans, and 620 to 680 for mortgages to qualify for an installment loan. Those with lower scores can still potentially qualify for subprime lending.
How does an installment loan affect your credit score?
The hard credit check when applying can lower your score a bit initially. But responsibly managing the loan with on-time payments can improve your credit history and scores over the long run.
What are the pros and cons of installment loans?
Pros include predictable payments, access to lump sums, potential credit building, and lower rates than credit cards. Cons include long repayment terms, fees for early payoffs or missed payments, collateral risks, and credit requirements.
When should you get an installment loan?
Installment loans are useful for major financial goals like home buying, college tuition, auto purchases, or consolidating high-interest debts that could benefit from structured repayment over years.
What are alternatives to installment loans?
Alternatives include revolving credit like credit cards and lines of credit, home equity loans, payday alternative loans from credit unions, buy now, pay later financing, borrowing from retirement accounts, and more.
In another related article, Subsidized vs Unsubsidized Student Loans: A Complete Comparison Guide
