Installment loans can be used to finance nearly every large expense. They allow individuals to borrow a lump sum of money and repay the balance over a set repayment period in monthly installments — hence the name.

Chances are, you’ve had an installment loan before or know someone who has, since they’re the most common form of financing and are offered by nearly every financial institution. Personal loans are the most popular category, but mortgages, auto loans and student loans also fall under the umbrella of installment loans.

How installment loans work

After taking out the loan, the borrower will repay the total amount — with interest — in smaller installments over a set period until the balance is paid off. These payments are made monthly and, depending on the product, can be paid off in a matter of weeks, months or years.

Installment loans are different from credit cards or lines of credit, as the amount of money you receive upfront is predetermined and disbursed all at once. The repayment schedule is typically less flexible than those of revolving products, which comes with the benefit of knowing exactly how much you owe each month.

The two types of installment loans

There are two types of installment loans: unsecured and secured loans. Secured loans are often used for larger purchases or are offered to borrowers with a less-than-stellar credit score or a thin credit history. Mortgages and vehicle loans are common examples of secured loans.

Secured loans are backed by collateral — like your home or vehicle — which can be seized if you default on the loan. While this can pose a risk to the borrower if they fail to make their payments, lenders are often more lenient with their eligibility criteria when it comes to secured loans and often offer low interest rates.

Unsecured loans aren’t backed by collateral and are offered by banks, credit unions and online lenders. Because lenders assume a higher level of risk by not requiring collateral, the eligibility requirements are often more stringent and rates are much higher than with secured loans.

What an installment loan can be used for

Because “installment loan” includes most loan types, one can be used to cover a wide range of purchases and expenses.

Purchasing a home

A mortgage is a secured installment loan in which your home acts as collateral. Most mortgages come with 15 or 30 year repayment periods and carry a fixed interest rate.

Financing a vehicle

Auto loans are installment loans that are offered both at dealerships and through lenders outside of them.

Like with any other loan, your interest rate is based on your creditworthiness. You’ll also make the set monthly payments until the balance is paid off, and if you fail to make the payments the dealership can seize your car to satisfy the delinquent payments. Make sure the monthly amount is well within your budget before taking out the loan.

Student loans

Student loans come in two forms: private and federal. And while both options are installment loans and serve the same purpose, they have stark differences. Private student loans are offered by online lenders, banks and credit unions and often come with specific eligibility requirements that can be difficult to meet as a student.

Unlike federal loans, many private lenders don’t have a borrowing limit and can cover up to 100 percent of the total cost of attendance. However, depending on your creditworthiness they can come with high interest rates, especially in the case of variable-rate loans.

Federal student loans are offered by the federal government and are available to every student attending an eligible school. The application process is streamlined through the Free Application for Federal Student Aid (FAFSA) in which students also can apply for federal need-based aid. Loan approval and rates aren’t based on financial standing and are fixed, meaning they remain the same until you pay off the loan.

Emergency expenses

Installment loans are the most common way to finance an unexpected medical bill or expense. Depending on the situation you may be able to negotiate a payment plan for particularly large debts, like an emergency vet expense or a hospital bill.

Borrowers will often turn to personal loans when faced with an unexpected situation or crisis. Personal loans are offered by financial institutions or lenders and can be used to finance nearly any legal expense. Some lenders may have restrictions on what the loan can be used for, so read the terms and conditions carefully.

Debt consolidation

A debt consolidation loan is an unsecured loan that allows you to consolidate multiple lines of high-interest debt into a new personal loan with one, fixed monthly payment. Borrowers often consolidate their debt to organize and streamline their monthly payments and to save money by decreasing the amount of interest paid.

It only makes sense to take out a debt consolidation loan if you’re offered a lower interest rate on your new loan than the rates of your original debts, so shop around to make sure you’re getting the best rate for your credit situation.

A large purchase

While it’s not recommended for every situation, large purchases and events can be financed with a personal loan. Vacations, weddings and big-ticket jewelry items can be financed to make the costs more manageable. There are lenders that offer purchase-specific personal loans, like jewelry or wedding loans as a way to simplify the application process for borrowers.

Buy now, pay later loans are a popular installment loan option geared toward individuals who need short-term payment assistance. While similar to personal loans, BNPL loans can be used wherever offered, and typically don’t come with an APR.

While using an installment loan for a large expense or event seems like a smart way to manage the upfront cost, the interest accrual alone could end up costing more than the original expense. To save money, do your research and make sure you’ve exhausted every other funding option before signing on the dotted line.

When to not use a personal installment loan

An installment loan may not be the best option for you if your financial situation isn’t stable. If you have an income that varies from month to month, ensure you can make the monthly payments in full each billing period before applying.

If you miss a payment it’ll knock your credit score and remain on your credit report for up to seven years. This can make it more difficult to get approved for other purchases — like a home or car — down the road.

You also may want to rethink taking out an installment loan if you don’t need the funds urgently. If you have some time under your belt, it may make more sense to focus on saving for the expense, rather than taking out a loan.