What is an installment loan?

Installment loans are a form of credit where you borrow a set amount and pay it back with interest over a monthly schedule. Because it is a broad term, “installment loan” can refer to a wide variety of loans — so common rates, terms and fees vary significantly between lenders.

Still, installment loans are a handy tool when you need to cover a larger expense and want to have steady, fixed payments to budget around.

Types of installment loans

There are a few main types of installment loans available to consumers:

  • Personal loans are generally unsecured, which means they don’t require collateral. You can borrow anywhere from $1,000 to $100,000 from a variety of lenders, and there are options to fit every budget and credit profile.
  • Auto loans are secured by the vehicle you purchase. You can borrow directly from a lender or opt for dealership financing. Either way, you may see lower rates than a personal loan — but be prepared for more restrictions on how much you are able to borrow.
  • Mortgages are secured by your property or home. You can borrow a significant amount with a mortgage at low rates, and most lenders offer 30 years to pay back what you borrow and build equity in your home.
  • Home equity loans and home equity lines of credit (HELOCs) are secured by the equity you build in your home. Because of this, they have lower rates than other installment loans and you can generally borrow more.
  • Student loans are unsecured and designed to cover college or university expenses. Most allow you to postpone payments until after you graduate or make interest-only payments while you are in school.

Secured vs. unsecured installment loans

Lenders may require you to provide collateral to back your loan. It could mean lower rates, but it also means losing that collateral if you default.

Secured installment loans — like mortgages and auto loans — use the property you purchase with the loan as collateral. This results in lower average rates, although the rates you receive will depend on your credit profile, income and other debts.

Unsecured installment loans — like personal loans and student loans — only use factors like your credit score and income to determine your eligibility. Because the lender takes on more risk, rates tend to be higher.

Pros of installment loans

Installment loans — whether secured or unsecured — can be beneficial for borrowers looking to fund a large expense like a car purchase or home renovation.

  • Fixed payments. All installment loans offer fixed payments because they have fixed interest rates. This helps you budget each month without having to worry about the amount you owe changing.
  • Long repayment terms. Although there are some personal loans with short repayment terms, most lenders offer you three to seven years to repay personal or auto loans. Student loans and mortgages frequently have longer terms ranging from 10 to 30 years.
  • Wide availability. Installment loans are widely available from banks, credit unions and online lenders. No matter your credit score or income, you will likely be able to find an installment loan that fits your needs.

Cons of installment loans

Because installment loans cover a wide variety of products, there are quite a few drawbacks to borrowing them, especially if you don’t have the credit score to qualify for a low interest rate.

  • Strict eligibility criteria. There are lenders that work with poor credit, but most will require a good credit score of at least 660 before it will consider you. In addition, you will need sufficient income and minimal debt.
  • Collateral frequently required. Most types of installment loans require collateral — including some personal loans. If you aren’t willing to take out a secured loan, you may be better off with a fully unsecured option like a credit card.
  • Multiple fees. From origination fees to late fees, lenders can charge you for a variety of things. There could be document processing fees, closing fees and quite a few other costs that cause the total amount you pay to your lender to balloon.

Types of installment loans to avoid

Unfortunately, “installment loan” is a broad term with a variety of definitions. Most installment loans are personal loans with interest rates under 36 percent. But depending on your state, you may also come across installment loans that charge interest over 100 percent.

These function more like extended payday loans. You will have a few months to pay back a small amount of money, and interest — or fees — will add up quickly.

Avoid these if possible. Predatory loans like short-term installment loans can put you in a cycle of expensive debt that can be difficult to break.

What to look for in installment loans

While you should be aware of the lender’s customer service and reviews, interest rates, loan terms and fees will be the bigger factors when determining if an installment loan is worthwhile.

  • Interest rates. Interest rates vary widely between installment loans, but for any loan, rates will cap at 36 percent. If you have good to excellent credit, you may be able to get an installment loan with lower interest rates, although it will also depend on your income and other debt.
  • Fees. Lenders often charge late fees if you miss a payment, but you should also look for origination fees and prepayment penalties. An origination fee is essentially the cost to borrow the loan and is deducted from the total loan amount before you receive it. A prepayment penalty is a fee for making an early payment — which is the lender’s way of recouping interest.
  • Loan terms. Personal loans may have terms as short as one year while mortgages and home equity loans can last 30 years. The loan term your lender offers on an installment loan should fit your budget. Remember: the longer the loan term, the more you will pay in interest.

Bottom line

Installment loans can be secured or unsecured, which make them a versatile option to cover your expenses. Once you determine the type of installment loan you need, compare lenders to find the interest rates and terms that suit your budget.