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- Installment loans can include mortgages, auto loans and personal loans.
- Interest can be calculated at a fixed or variable rate.
- Some installment loans are unsecured, while others, like mortgages, are backed by collateral.
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.
Personal loans are the most common type of installment loans. However, 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.
Some of the most common uses for personal loans include:
- Emergency expenses: Personal loans often feature a quick approval process. Many lenders will send the funds to your account the next day after clearing any necessary verifications. This makes them a good alternative if you’re faced with an unexpected medical bill, an emergency car or home repair.
- Debt consolidation: A debt consolidation loan is a type of personal loan that allows you to roll multiple lines of high-interest debt into a single account with a fixed monthly payment. Borrowers often consolidate their debt to organize and streamline their monthly payments and save money by decreasing the 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.
- Big-ticket items: While not recommended for every situation, large purchases and events can be financed with a personal loan. Vacations, weddings and even home improvement projects can be financed to make the costs more manageable.
There are lenders that offer personal loans for nearly every expense — from weddings to adoption costs to vacation-related purchases. While most personal loan lenders place few restrictions on how to use the funds, not every lender or financial institution will offer loans for the same purpose. 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, meaning that the loan is backed by your vehicle as 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 the federal government and online lenders, nearly 43 million borrowers currently hold student loans in the country.
The Education Department offers federal student loans 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.
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 loans typically come with lower rates than credit cards and lines of credit. Plus, interest can be fixed, which makes payments more predictable than the former. You could also see your credit score increase with on-time payments.
On the downside, if you have less-than-perfect credit, you could pay higher fees for the amount borrowed. If you have an installment loan with a variable rate, you could also see your payments increase and the amount that goes toward interest, depending on market conditions. Lastly, just like on-time payments can positively impact your credit, late or missed payments could negatively impact your score for years to come.
Once you’ve identified the type of installment loan that best suits your needs, the next step is to compare lenders and terms. This includes checking each of the lender’s eligibility requirements, comparing interest rates, fees, and repayment terms.
Don’t rush into taking out a loan without thoroughly considering your options. Also, remember to only borrow what you can afford to pay back. Keep in mind that while installment loans can be a great tool to manage larger expenses, they should not be used as a long-term solution for financial problems.