An installment loan is a set amount of money you borrow that is repaid with interest through fixed monthly payments. The interest rate can depend on several factors, including the loan size and credit score of the applicant, and repayment terms can range from a few months to over 30 years. Installment loans can be unsecured or secured by personal property and other forms of collateral. These loans are considered installment credit, which you borrow in one lump sum, versus revolving credit (i.e. credit cards), that you can reuse over time.
To help you get a full understanding of installment loans, here are some details on the different types, pros and cons, and much more:
Types of installment loans
Four of the most common types of installment loans include mortgages, auto loans, personal loans and student loans. Most of these products, except for mortgages and student loans, offer fixed interest rates and fixed monthly payments. You can also use an installment loan for other purposes, like consolidating debt or refinancing an auto loan.
Pros and cons of installment loans
To make an educated decision, it can help to see the good and the bad. Here are some basic pros and cons of installment loans:
Pros
- Fixed monthly payments – Your payment will be the same every month, making it easier to budget.
- Fixed interest rates – Your interest rate will always stay the same, even if the market changes.
- Helps to diversify your credit mix – Adding a new or additional installment loan shows lenders that you’re responsible and can successfully manage different types of credit.
- Builds your credit score – If you make your monthly payments on time, your score can go up.
Cons
- Potential fees and penalties – Some loans may have origination fees or prepayment fees.
- Potential high interest – Depending on the lender and the borrower's credit scores, some loans can feature high interest rates.
- Potential requirement of collateral – If a lender believes you may have trouble paying back your loan, they might require you to provide collateral.
Although there are possible downsides to installment loans, they can be a useful loan option for people with good, near prime or bad credit. Riskier loan options, such as payday loans, can seem appealing, but have their own drawbacks.
The difference between installment loans and credit cards
Even though installment loans and credit cards are two of the most common ways to borrow money, they’re different in a lot of ways. Here are some of the main differences:
- Monthly payment – Installment loans normally require equal monthly payments until the balance is paid in full. However, credit card monthly payments can fluctuate due to the outstanding balance and interest rate.
- Available funds – When you take out an installment loan, the amount you borrow is in a fixed lump sum. If you want to add to the loan, you may have to fill out another credit application. With credit cards, the amount of credit available is based on your current balance and credit limit. If you want a higher credit limit, some lenders may offer you one based on a good repayment history.
- Interest rate – Most installment loans offer fixed interest rates that are locked in for the life of the loan. Credit card interest rates can increase for a variety of reasons including late payments, variable interest rates and when a promotional rate expires.1
For more information, check out our article on personal loans vs. credit cards.
How to get an installment loan
If you feel like an installment loan is the right choice for you, there are some helpful steps you can take before you apply. First, try using a personal loan calculator. This can help you get an estimate of what your monthly payments might look like and how the options will fit in your budget. Then, check your credit to avoid any surprises when you apply. You can check it for free once a year at annualcreditreport.com.
Next, gather your personal documents. What you need to apply for a loan may vary by lender, but commonly required documents include proof of identity, proof of residence, proof of income and Social Security card. Finally, take the time to research different lenders. Websites like the Better Business Bureau and Trustpilot offer ratings and customer reviews to help you choose which lenders are the best fit for you.
Know before you borrow
If you’re considering an installment loan, it’s important to understand how they work and compare them with other borrowing options. Hopefully this information helps you decide what’s best for you when the time comes.
1. Irby, Latoya. “Learn When Banks Can Increase Credit Card Interest Rates.” TheBalance.com. https://www.thebalance.com/when-can-banks-increase-credit-card-interest-rates-961126 (accessed November 20, 2019).
*This article has been updated from its original posting on July 13, 2017.
