What is an Installment Loan?

If you need extra funds to buy a new car or tackle that home renovation project you've put off for a while, an installment loan may be a great option. Whether you're making a major purchase or consolidating debt, installment loans can help provide you with the financial flexibility to achieve your goals while spreading the cost into affordable monthly payments. To help you get an understanding of installment loans, here are some details on the different types, pros and cons, and much more.

How does an installment loan work?

An installment loan is a set amount of money that you borrow then repay with interest, usually through fixed monthly payments. The amount of the monthly payment includes a portion of the principal (the original amount borrowed), and interest (the cost of borrowing the funds), as well as other financed amounts. Repayment terms could range from one to over 30 years.¹ The terms of the loan, including the interest rate and repayment period, may differ depending on the following factors:

• The lender's requirements
• The amount of the loan
• Your creditworthiness
• Your ability to repay the loan
• Whether collateral is pledged

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 (e.g., credit cards), which you can reuse over time.

Types of installment loans

Four of the most common types of installment loans are mortgages, auto loans, personal loans and student loans.

Mortgage loans

Mortgage loans are used to purchase homes or refinance existing mortgages. They usually have terms of eight to 30 years, though other durations can be available.² Interest rates can be fixed or adjustable and are influenced by the borrower's credit score, the size of the down payment, and market conditions. Mortgages are secured loans, with the home serving as collateral. Failure to make payments could result in foreclosure.

Auto loans

Auto loans are used to purchase new or used vehicles and typically have terms ranging from 24 to 84 months.³ Interest rates for auto loans vary based on factors such as the borrower's credit score, the loan term and the lender's requirements. Auto loans are secured, meaning the vehicle serves as collateral and could be repossessed if payments are not made.

Personal loans

Personal loans are a type of installment loan that can be used for various personal expenses, such as, auto repairs, medical bills or emergency expenses, to name a few. Personal loans typically have terms ranging from two to seven years, depending on the lender, although some lenders provide terms for more or less time.⁴ Many lenders evaluate applications based on the borrower's credit score and income, while lenders like OneMain focus on the borrower's ability to repay, looking beyond their credit score.

Student loans

Student loans finance higher education costs, including tuition, books and living expenses. The terms of these loans vary from 10 to 30 years, depending on the loan type and repayment plan.⁵ Student loans can be federal or private, with federal loans offering more flexible repayment options and protections.

Most of these products, except for some mortgages and student loans, offer fixed interest rates and fixed monthly payments. You can also use an installment loan for other purposes, like planning a much-needed vacation or giving your budget more wiggle room.

Pros and cons of installment loans

To make an educated decision about taking out an installment loan, it can help to weigh the good and the bad. Here are some basic pros and cons of most installment loans:

Pros	Cons
• Fixed monthly payments– If you have a fixed interest rate loan, your payment will be the same every month, making it easier to budget.	• Potential fees– Some loans may have an origination fee— a one-time fee to cover loan processing costs or prepayment fees—penalties for paying off your balance early.
• Fixed interest rates– If you get a fixed rate, your interest rate will always stay the same, even if the market changes.	• Less flexibility— Funds are provided in a lump sum so you can’t borrow additional money unless you apply for another loan.
• Helps to diversify your credit mix– Adding a new or additional installment loan and successfully managing your payments shows lenders that you’re responsible and can manage different types of credit.	• Potential requirement of collateral– If a lender believes you may have trouble paying back your loan, they might require you to provide collateral. For example, if you fail to repay your mortgage, the lender can foreclose your home.
• Builds your credit score– If you make your monthly payments on time, your score may go up.

Although there are possible downsides to installment loans, they can be useful loan options for people with credit scores that are good, near prime or may need some improvement. Riskier loan options, such as payday loans, can seem appealing but have distinct drawbacks.

Installment loans vs. revolving credit

Installment loans and revolving credit are two of the most common ways to borrow money, but they’re also different in many ways. Installment loans allow you to borrow a fixed amount of money and repay it in regular, scheduled payments over a set period. Revolving credit allows you to borrow money on a repeated basis up to a set limit, and you pay it back over time by making minimum payments — or more as your finances allow. The most common types of revolving credit include:

• Credit cards: Monthly payments can fluctuate due to the outstanding balance and interest rate. 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. Credit card interest rates can increase for a variety of reasons, including late payments, variable interest rates and an expired promotional rate.

• Home equity line of credit (HELOC): A HELOC uses the equity in your house as collateral. Lenders offer competitive interest rates for these loans, which can benefit you. Regarding credit score impact, merely taking out a home equity loan and not using it immediately can boost your score. However, if you withdraw a large portion from the loan, that could negatively impact your credit score.

• Personal lines of credit: These are another option that allows you to withdraw funds as needed. Instead of receiving the full amount of approved funds at one time, however, you have access to a set credit limit that you can borrow from as needed. After you qualify, the lender will likely designate a period of time when you can draw money from the account, a “draw period.” Learn more about the differences between a personal loan and a line of credit.

Steps to take before applying for an installment loan

If you feel like an installment loan is the right choice for you, take a few helpful steps before you apply. First, try using a personal loan calculator. This can help you guestimate your monthly payments and how they will fit your budget. Then check your credit to avoid any surprises when you apply.

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. You can check for offers and customer reviews online at sites like Trustpilot or within your circle of family and friends to help you choose which lenders are the best fit for you.

Want to borrow? Now you’re ready.

Now that you understand how installment loans work, you may be ready to look into your borrowing options with confidence—and choose what's best for you when the time comes.

To learn more about getting a personal loan with OneMain, check out our personal loans page.

Sources:

1. https://www.bankrate.com/loans/personal-loans/what-is-an-installment-loan/#what
   
2. https://www.bankrate.com/mortgages/what-is-mortgage/
   
3. https://www.bankrate.com/loans/auto-loans/what-is-an-auto-loan/#compare
   
4. https://www.nerdwallet.com/article/loans/personal-loans/personal-loan-term-length
   
5. https://www.consumerfinance.gov/ask-cfpb/how-long-does-it-take-to-pay-off-a-student-loan-en-621/
   

This article has been updated from previous postings through 2017-2021. Matt Diehl, John Frizzera and Kim Gallagher contributed to this article.