Common types of installment loans and their best uses

Unlike credit cards, installment loans are a type of close-ended debt, meaning you can’t borrow as you go. 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, and installment loans tend to have much lower rates than credit cards.

Because of their structure, you may be able to borrow more than you could with a credit card. This makes installment loans a flexible option for large expenses like paying for school, buying a car or even purchasing a house.

5 most common types of installment loans

Installment loans are one of the most common ways to finance life’s bigger expenses. While they all operate similarly, the most common installment loans have different functions and interest rates.

While personal loans are the most common type of installment loans, auto loans, student loans, buy now, pay later loans and mortgages are also popular — and often necessary — financing options.

1. Personal loans

Personal loans can be used for essentially every legitimate expense and are offered by banks, credit unions and online lenders. The balance is repaid in fixed monthly installments, and they also tend to have fixed interest rates. Most are unsecured, which means collateral isn’t required. Because of this, they tend to have higher interest rates than secured options like mortgages or auto loans.

There are lenders that offer personal loans for nearly every expense — from weddings to adoption costs to vacation-related purchases — but not every lender or financial institution will offer loans for the same purpose. Some companies have restrictions on what the funds can be used for, so make sure your needs are met before signing on the dotted line.

2. Auto loans

Auto loans are meant specifically for purchasing a vehicle. While many dealerships offer in-house financing, you can also find direct auto loans through credit unions, banks and online lenders. They tend to offer lower rates and more repayment flexibility.

Before applying, conduct a financial audit and craft a repayment plan that works with your budget. Just like personal loans, auto loans tend to offer fixed interest rates. However, auto loans are a secured debt, which means that the loan is backed by your vehicle as a form of collateral. If you default on your loan, the bank has legal authority to seize your vehicle to satisfy the delinquent debt.

3. Student loans

Student loans are used to finance a college education and related expenses like books, supplies, housing and food. Offered by both the federal government and online lenders, nearly 43 million borrowers currently hold student loans in the country.

Federal student loans are offered by the Education Department through one streamlined application: the FAFSA. Federal loans are available to every borrower attending an eligible U.S. college or university, and they all have the same fixed interest rates. Due to the unique benefits and protections available to borrowers, it’s best to turn to federal loans before considering private lenders.

Private student loans base your approval odds and interest rates on your creditworthiness, and they can be difficult to qualify for as a student. Unlike federal student debt, private loans are disbursed by a number of financial institutions and online lenders. Each company will have different eligibility requirements and interest rate ranges, so shop around to make sure you’re getting the best rate for your situation.

4. Mortgages

Mortgages are offered by a number of institutions, from national banks to credit unions to 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 will allow you build equity and pay down the loan faster, while a 30-year mortgage gives your wallet some breathing room in the short term by charging a lower monthly amount.

5. Buy now, pay later loans

Buy now, pay later (BNPL) loans break up the cost of a purchase into installments so that people can afford more than they otherwise would be able to. Most retailers — especially online retailers — now offer some form of BNPL options.

With a positive repayment history, BNPL loans often don’t charge interest or fees. Plus, they’re a convenient way to afford purchases without racking up credit card debt and can be easier to get approved for than a traditional personal loan.

There are different types of BNPL loans. Some companies require a hard credit check while others don’t, and some companies may report your repayment habits to the credit bureaus to help you build your credit score. However, a potential downside of these loans is that borrowers may be tempted to finance more than they can afford.

Pros and cons of installment loans

Just like every other type of financing, installment loans have advantages and disadvantages that you should consider before making a decision.

Installment loan credit requirements

While each company and type of loan will have unique requirements, lenders generally only consider borrowers who have a minimum credit score in the low- to mid-600s. However, people with a credit score in the mid-700s and into the 800s will be eligible for the most competitive rates and terms.

If you have a less-than-stellar score or a thin credit history, you can still be approved for an installment loan, but it may be more difficult to find a lender. While there are lenders that offer bad credit loans, the interest rates and fees are often on the higher side.

Next steps

Once you decide which type of installment loan best suits your needs, make sure to shop and compare offers from at least three lenders. This will help you get the best terms and rates available for your financial situation and credit profile. If possible, choose lenders that offer prequalification so you can preview your rates without hurting your credit.