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Installment loans — loans that allow you to borrow money and pay it back in equal monthly payments with a fixed interest rate — are a handy personal finance tool if you’re looking to pay off sizable debts in small, manageable chunks.
What is an installment loan?
Installment loans allow individuals to borrow a predetermined amount of money, disbursed in a lump sum, that can be repaid over time. Typically, these loans come with a fixed interest rate and require regular monthly payments that remain the same each month. A portion of each monthly payment is applied to the principal amount borrowed, and a portion is applied to the interest on the loan.
Installment loans differ from credit cards or lines of credit, which typically have more flexible repayment terms and variable interest rates — meaning you don’t have a predictable monthly payment. With installment loans, you always know what to expect when your monthly bill is due.
Types of installment loans
Installment loans come in many forms. Although they operate similarly, each type comes with different features, loan purposes and average interest rates.
A personal loan is money provided by a lender that can be repaid in monthly installments over a fixed period at a fixed interest rate. These loans are available from online lenders, private lenders and credit unions.
The proceeds from a personal loan are provided in a lump sum and can be used to fund various needs.
“A personal loan can be a great financing option for consumers looking to budget a wide range of expenses from car repairs to home improvements,” says Mark Victoria, head of unsecured lending for TD Bank. “A very common and effective use of a personal loan is to consolidate higher interest credit card debt.”
The repayment terms for personal loans usually range from 24 months to 60 months, but some can go as high as 72 months.
|Fixed interest rate||Interest rates may be higher|
|Fixed monthly payments||Origination fees and prepayment penalties|
|Lump sum payment||Eligibility requirements|
|Money can be used for various purposes||Higher payments than credit cards|
Payday lenders often provide no-credit-check loans that don’t check your credit score before lending money. Payday loans are intended to help consumers during an emergency or when they don’t have another source of credit. The amount of a payday loan is smaller than a personal loan, often limited to about $500.
Payday loans are often short-term, high-cost loans. When applying for these loans, your credit score does not matter because your paycheck is used as security against the amount borrowed.
When approved for a payday loan, you give the lender a postdated check for the amount being borrowed plus any fees. The lender holds onto that check and gives you cash. On your next payday, the lender cashes the check you provided.
If you take an online loan, you authorize the company to take the funds from your bank account on your next payday once your employer has paid you.
|No credit check||High interest rates|
|Rapid approval timeline||Short repayment timeline|
|Funds provided quickly||Fees|
|No collateral required||Limited loan amount|
Another common installment loan is a mortgage. The most popular mortgages require homeowners to pay back the money borrowed over the course of 15 or 30 years with a fixed interest rate. Because a mortgage is backed by collateral, such as a house or condo, the interest rates tend to be lower.
|Fixed interest rate||Long repayment commitment|
|Fixed monthly payment||Can be harder to qualify|
|Long repayment timeline||If you fail to make payments, home can be foreclosed upon|
|Lower interest rates||When including interest over 15 to 30 years, overall cost is significant|
Car loans are another popular type of installment loan. Typically, consumers make a down payment on a car or apply the trade-in value of their existing car, then finance the purchase price balance with a car loan. Monthly payments are made to lenders until the car loan is paid in full.
|You don’t have to pay the full vehicle cost upfront||Good credit score is required for the best interest rates|
|Fixed monthly payment amount||If you default, the vehicle can be repossessed|
|Loan helps to build your credit profile<||Car depreciates over life of the loan|
There are two types of student loans—private and federal. Both serve the same function and are installment loans. The most popular of the two are federal student loans, which generally are available to any student who needs one. There are no minimum credit score requirements to obtain a federal student loan and with the exception of the Direct PLUS loans for parents, graduate students and professional students, there is no credit check involved.
Another benefit of federal student loans is that the interest rates are standardized, meaning every borrower pays the same rate. In addition, the interest rates for federal student loans are also fixed.
Unlike most private student loans, federal loan programs offer a variety of repayment benefits, including loan forgiveness programs, income-driven repayment plans and forbearance and deferment options.
|Federal student loans are available to any student who needs one||Caps on how much you can borrow|
|No minimum credit score for federal student loans and no credit check unless you’re applying for a Direct PLUS loan||Repayment can take anywhere from 10 to 30 years|
|Standardized and fixed interest rate||Long term repayment commitment|
|Forgiveness and deferment programs are available||The interest could amount to tens of thousands of dollars over the life of the loan|
Buy now, pay later loans
Buy now, pay later loans are a short-term financing method that allows you to make purchases and pay for them in interest-free installment payments. The payments are made over a specific period, which is generally a few weeks,
These services provide convenience but can also cause you to get easily caught up in overspending, encouraging you to spend more than you can repay. These types of loans also create the illusion that products or purchases are less expensive than they are.
|Interest-free payments||Temptation to spend more than you can afford or make unnecessary purchases|
|Makes expensive purchases more manageable||Illusion that purchases are less expensive|
|Easy to get approved||Easy to get into debt|
|Does not impact credit score in most cases||Down payment may be required at checkout|
Pros and cons of installment loans
The benefits of installment loans may make them an attractive option, but it’s important to consider the possible disadvantages that accompany these loans too.
Pros of installment loans
Installment loans have many advantages. A few include:
- Consistent monthly payments: Monthly payments remain the same for the duration of the loan, making it easier to create a household budget and pay bills on an ongoing basis.
- Credit score boost: Establishing a clean payment history with no late payments on an installment loan helps improve your credit score.
- Refinancing opportunities: If interest rates fall or your credit score improves, refinancing into a new loan can be beneficial because it will likely lower your loan’s monthly payments or reduce the loan’s length.
Cons of installment loans
If you’re thinking about taking out an installment loan, make sure to take into consideration some of the drawbacks:
- Fixed payment: Since installment loans deposit funds in a lump sum, you can’t increase the amount borrowed if you run into a new financial hurdle or emergency.
- Potentially long payment schedule: Installment loan payment periods can be lengthy. It’s important to make sure you’ll be able to make the payments on time each month for the entire length of the loan you’re agreeing to. Conversely, if you’d like to pay off your loan early, be aware of any prepayment fees your lender may charge.
- May be expensive for poor credit: The interest rate you receive from an installment loan largely depends on your credit score. If you have below-average credit, you may be denied a loan or offered a high interest rate that will make monthly payments more expensive.
- Potential fees: If interest rates decline, you can opt to apply for another personal loan at a lower rate. However, you may have to pay another origination fee to process the loan.
Should you get an installment loan?
When deciding whether to get an installment loan, you should weigh the pros against the cons. For example, if taking out an installment loan can help you refinance your high-interest debt, taking out this type of loan could be a good idea. In addition, if you prefer a fixed monthly payment, it can be a better option than using a credit card or line of credit.
However, if you have bad credit, taking out a loan might not be a good idea unless you apply with a cosigner with good credit to potentially get a lower interest rate. Also, if you prefer borrowing money on an as-needed basis, an installment loan won’t be your best option.
If you decide taking out an installment loan is the best option for you, make sure you can afford to repay your debt on time. If you default on a loan, it could cause significant damage to your credit score, harming your ability to access credit in the future.
Where to get an installment loan
Installment loans can be obtained through a bank, credit union or online lender, but each comes with key benefits and drawbacks to consider.
Banks are more easily accessible than credit unions as you don’t need to be a member to access loan products. However, they tend to have more stringent lending criteria.
Furthermore, you’re likely to get a more competitive rate with a credit union or online lender since they have lower overhead costs. Online lenders also feature a more streamlined application process, rapid approvals and faster funding times as everything is automated. But you won’t have the luxury of visiting a branch and speaking with a loan officer face-to-face like you would with a bank or credit union.
The good news is that many lenders allow you to apply for a mortgage, car loan or personal loan online. Personal loans are often approved within a few days, while car loans and mortgages require a more extensive check into your credit history and credit score.
No matter what loan you seek, we recommend checking rates from a few different lenders before committing. Many online lenders offer prequalification, a process in which you enter a few details about yourself and your desired loan terms in exchange for a quick decision about whether or not you’d qualify for a loan with that lender. Prequalification uses a soft credit check, meaning your credit score won’t be impacted.
Alternatives to installment loans
Installment loans are not the only way to access the cash needed to make large purchases or to pay off debt. Here are some other options.
Personal lines of credit
A personal line of credit (PLOC) is a typically unsecured, revolving credit line account that has a variable interest rate. These accounts function much like credit cards. You apply for a specified amount of credit, then access the money as needed. Repayments are based on the amount of money that’s been used.
Applying for a PLOC does not require providing collateral, such as your home. However, PLOCs are often reserved for consumers with a very strong credit history, often those who have a credit score of 680 or more.
Generally offered by community banks and credit unions, credit-builder loans are aimed at those who do not have a strong credit score or little to no credit history.
With credit-builder loans, you request a specific sum of money from a lender and make monthly payments toward the borrowed amount.
However, in the case of a credit-builder loan, you do not get the cash upfront. Instead, the lender deposits the loan amount into a secure savings account controlled by the lender. The consumer makes fixed monthly payments toward the loan for a specified amount of time, and once the total loan balance is paid in full, the lender releases the funds.
The main advantage of a credit-builder loan is that during the repayment period, the lender will report on-time payments to credit bureaus. So even though you will not have access to the cash during this period, you’ll still be improving your credit score.
Payday alternative loans
If you’re a credit union member, you may also consider a payday alternative loan (PAL). These loans are available to people who have been credit union members for at least one month, and they typically allow for borrowing between $200 and $1,000 for between one and six months.
Installment loans are a convenient option for consumers looking to cover a large expense, unexpected financial emergency, consolidate high-interest debt or buy a car or home. But before you apply, it’s vital to understand how different types of installment loans work. It’s equally important to shop around with different lenders to find a loan product with favorable terms that works for your financial situation.