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.
The most common type of installment loan is a personal loan, but other examples of installment loans include no-credit-check loans, mortgages and auto loans.
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 of time 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 a variety of 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.
No-credit-check loans are often provided by payday lenders 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.
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 you’re 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 you’ve been paid by your employer.
The amount of payday loan is smaller than a personal loan, often limited to about $500, but in some cases, limits are higher.
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.
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 balance of the purchase price with a car loan. Monthly payments are made to lenders until the car loan is paid in full.
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 the monthly payments on your loan or reduce the length of the loan.
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 you should 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. Shopping around will help you receive the lowest fees and interest rates.
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.
“Like all loans, the lender decides whether you qualify based on your income, credit history and credit experience,” says Todd Nelson, a senior vice president at LightStream.
No matter what type of loan you’re seeking, 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 a credit card. 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 typically 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 who have 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 amount being borrowed.
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 member of a credit union, you may also consider a payday alternative loan (PAL). These loans are available to people who have been a member of a credit union for at least one month, and they typically allow for borrowing between $200 and $1,000 for between one and six months.