In short, an installment loan is a loan for a specific amount of money that is repaid with interest through a series of fixed monthly payments. The interest rate may depend on the financial history of the applicant and loan size 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.
To help you get a better understanding, here are some additional details to consider:
Types of installment loans
There are several types of installment loans that can be useful depending on your situation. For example, if you wish to buy a home or vehicle, you may not be able to pay the cost in full. However, if you get approved for an installment loan, you can complete the purchase and pay the loan back over time.
Other uses of installment loans include home improvements, medical bills and higher education. Here are four common types of installment loans:
- Mortgages
- Auto loans
- Personal loans
- Student loans
The difference between installment loans and credit cards
There are two fundamental categories of consumer credit: closed-end and open-end credit.1
Closed-end credit, such as installment loans, typically consist of a fixed loan amount used for one specific purchase.2 Open-end credit, like a credit card, is also referred to as revolving credit that can be used repeatedly for various purchases.3
Here are some more differences to consider:
- 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.
- Available credit - When you take out an installment loan, the amount you borrow is fixed. If you want to add to the loan, you may have to fill out another credit application. With credit cards, you’re provided a credit limit when you open the account but could receive a higher limit by making a series of on-time payments.
- 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 missed payments, a drop in credit score and variable interest rates.4
For more information, check out our blog on personal loans vs. credit cards.
Pros and cons of installment loans
As with most loans or financial agreements, installment loans have advantages and disadvantages. For instance, the loan could offer low monthly payments but a high interest rate. Or, you may have to pay a fee to open the loan but the amount you save with a fixed interest rate could be worth the cost. By examining all factors, you can make an educated decision.
Some pros and cons to consider include:
Pros
- Fixed monthly payments
- Fixed interest rates
- Helps to diversify your credit mix
Cons
- Potential fees and penalties
- Potential high interest
- Potential requirement of collateral
Although there are possible downsides to installment loans, it could be a useful loan option for people with good, near prime or bad credit. Unlike payday loans, which must be repaid in one payment, installment loans are repaid over time. In addition to having fixed payments and a known payoff date, installment loans could help boost your credit score by adding a new type of account to your credit mix.5
Know before you borrow
If you’re considering an installment loan, it’s important to understand how it works and how it compares with other borrowing options. Hopefully, this information helps you make the loan decision that’s best for you.
1. Debt.org. “Types of Consumer Credit & Loans.” Debt.org.
https://www.debt.org/credit/loans/ (accessed July 10, 2017).
2. Debt.org. “Types of Consumer Credit & Loans.” Debt.org.
3. Debt.org. “Types of Consumer Credit & Loans.” Debt.org.
4. Konsko, Lindsay. “5 Times Your Credit Card Issuer Can Raise Your Interest Rate.” NerdWallet.com https://www.nerdwallet.com/blog/credit-cards/credit-card-issuer-raising-interest-rate-5-times/ (accessed July 10, 2017).
5. Konsko, Lindsay. “Will an Installment Loan Help Your Credit?” Nerdwallet.com. https://www.nerdwallet.com/blog/loans/installment-loan-boost-credit-fico-score/ (accessed July 11, 2017).
