Key takeaways

  • An installment loan is a debt that gives you funds all at once that are paid off in monthly amounts, called installments, over a set time period.
  • Installment loan payments usually include interest charges that are charged over the life of the loan and may be higher for borrowers with less-than-ideal credit.
  • Every lender has different eligibility requirements and offers different installment loan products, so do your research and read the fine print before applying.

Installment loans allow you to borrow money and pay it back in equal monthly payments, usually at a fixed interest rate. They can be handy and versatile personal finance tools.

For example, you can use them to make a major purpose or combine credit cards into one loan that you pay off in small, manageable chunks.

One well-known type of installment loan is a personal loan. Other examples of installment loans include student loans, mortgages and auto loans.

What is an installment loan?

An installment loan is a type of closed-end debt. You pay it off over a set number of months or years, also known as your loan term.

Unlike credit cards or lines of credit, which are open-ended, revolving credit, you can’t reuse the installment credit as you pay the balance. If you want to borrow additional money, you must apply for a new loan.

You can find several common types of installment loans:

  • Personal loans.
  • Mortgages.
  • Auto loans.
  • Student loans.
  • Payday loans.
  • Buy now, pay later loans.

To find these loans, go through institutions like banks and credit unions, online lenders, mortgage brokers and dealerships.

Installment loans may be secured or unsecured.

Secured installment loans

A secured loan requires a lien against an asset like a home or car. If you can’t repay the loan, the lender can take your asset as payment for any balance due. Examples of secured loans include mortgages and auto loans.

Secured installment loans may take more time to get. For instance, the approval process for mortgages averages 40 days and involves extensive paperwork. However, your approval might depend less on your credit score than with an unsecured installment loan.

Unsecured installment loans

Personal loans and buy now, pay later (BNPL) loans count as unsecured installment loans. These do not require collateral. The approval process is simpler and usually based on your credit scores, income and debt.

Unsecured personal loans can be funded in as little as the same day you sign and loan amounts are typically under $100,000.

How does an installment loan work?

Installment loans allow you to borrow an approved amount of money, disbursed in a lump sum. They can be repaid over a set period ranging from a few weeks (for a payday loan BNPL) to 30 years (for mortgages).

Typically, these loans have a fixed interest rate and require regular monthly payments.

One portion of each monthly payment goes to the principal amount borrowed and another goes to the interest on the loan. You’ll continue to make the loan payments over the loan term. The lender will close the account once the loan is paid in full, including the principal and interest.

Do installment loans hurt your credit?

Installment loans can harm your credit if you’re late on a payment or when you apply and undergo a hard credit check.

Try to choose personal loan lenders that offer prequalification without a credit pull. You will undergo a hard pull when you formally apply, but the score damage should be small and temporary.

A late payment damages your score more than a credit inquiry, so make sure you keep your payment current.

To avoid damaging your payment history, consider setting up automatic payments so you don’t miss a due date.

However, certain types of installment loan may have no effect on your credit score. Buy now, pay later financing typically does not require a credit check and payments may not be reported to credit bureaus. As such, they tend not to affect your credit.

Should you get an installment loan?

An installment loan makes sense if you can afford the payment, are financially stable enough to repay it and get some sort of financial benefit from it. Installment loans require a payment commitment that can last as long as 30 years.

If you plan to change jobs or anticipate ups and downs in your earnings, an installment loan may not be your best option.

See if an installment loan works for your situation by comparing installment loan lenders. Check out loan comparison sites to see offers side-by-side. If you’re buying a house, you might check with a mortgage broker, who can check different lenders for the best programs.

Also, make sure you compare quotes from at least three different companies to make sure you are getting the best rate.

If you ultimately decide an installment loan is not for you, explore alternatives to installment loans. Your options include personal lines of credit, credit cards and home equity lines of credit.

The bottom line

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.