What is an installment loan?

An installment loan is a common type of loan used to buy a car, house, or other major purchase. You may even have an installment loan that goes by another name, like a mortgage. Here’s what an installment loan is and what you need to know about these loans before you borrow.

How installment loans work

An installment loan is a lump sum of money that you borrow and repay in installments – or installments – over a period of time, usually months or years. Installment loans can be secured by collateral, such as a car, or not guaranteed.

Installment loans work differently from revolving credit — which you get with a credit card or home equity line of credit — because you borrow the funds all at once. You can’t get more money without applying for a new loan. And installment loans give you time to repay the loan, unlike payday loans which require full repayment from your next paycheck.

Examples of installment loans

Personal loans

Personal loans are installment loans that you can use for almost any reason. Loan amounts available range from $1,000 to $100,000 and repayment terms are generally two to seven years.

A lender decides if you qualify for a personal loan and at what rate using information such as your credit history and score, income and other outstanding debts.

Unsecured personal loans are more common than secured personal loans, but some lenders allow borrowers to use a savings or investment account or a vehicle as collateral for the loan to potentially qualify for a lower rate.

Mortgages

With a mortgage, you borrow the value of the home and agree to pay it back with interest in monthly installments, usually over 15 or 30 years.

In this case, the installment loan is secured by the home, and after too many defaults, you risk losing it.

A home equity loan — which is a second mortgage you might take out to pay for home renovations — is also an installment loan.

Car loans

An auto loan is another example of a secured installment loan. You borrow the cost of the vehicle and make monthly payments, plus interest, usually over two to five years. If you miss payments, the lender can repossess your car.

Student loans

Student loans are installment loans because you repay them in regular installments over time. They can have fixed or variable rates, however, and often include a period after you’ve borrowed the money when interest is accumulating but monthly payments haven’t started.

Buy now, pay later

Cash financing offered by “Buy now, pay later” companies is technically an installment loan. BNPL allows you to split a purchase into equal payments, often every two weeks. For example, if you split a $200 purchase into four smaller installments, you would pay off the loan in $50 installments.

How Installment Loans Affect Your Credit

Applying for an installment loan often requires a firm credit check, which can temporarily reduce your credit score by a few points. Beyond that, installment loans can boost your credit if you make regular, on-time payments.

Reputable lenders report on-time payments to at least one of the three major credit bureaus, Equifax, Experian and TransUnion. Payment history accounts for 35% of your FICO score, and installment loan payments help build that history.

The consequences of missed or late payments can be serious. A late payment of 30 days or more can cause your credit score to lose up to 100 points. Most lenders have the ability to set up automatic payments, which takes the pressure out of remembering to pay.

How to get an installment loan

  1. Compare. Lenders use different methods to assess your loan application and assign your rate, so it pays to compare installment loans from multiple lenders. Also consider other forms of financing, such as low-interest credit cards or lines of credit, especially for larger expenses.

  2. Pre-qualified. Being prequalified for a personal loan or preapproved for a mortgage allows you to see potential loan amounts, rates and payments without affecting your credit score. You can then assess the impact of the payments on your budget.

  3. Boost your application. Before applying, consider a joint or co-signed installment loan or get an unsecured loan with collateral. These options can help you qualify or get a lower rate or a higher loan amount. Just be aware that there are consequences if you are unable to repay the loan: your co-signer will be liable or the security could be taken.

  4. Apply. Installment loans are available at banks, credit unions, and online lenders. The time required to apply varies by loan type and lender.

Personal installment loans for bad credit

Borrowers with thin or imperfect credit profiles may be able to get an installment loan with bad credit (below 630 FICO). Some lenders have lower credit score requirements and consider other information, such as banking history, employment, education, and existing debts. Credit unions and online lenders can work with borrowers with bad credit, while banks tend to require good to excellent credit.

High Cost Unsecured Installment Loans

Lenders must disclose a loan’s annual percentage rate (interest rate plus any other fees), and personal finance experts say an APR of 36% is the maximum rate for a loan to be affordable. .

But you will find installment loans with rates of 100% or more. Lenders who offer high-interest installment loans may not review your credit and repayment capacity, and they may not report timely payments to credit bureaus. These are red flags that the loan is overpriced at best and predatory at worst.

Frequently Asked Questions

What is an example of an installment loan?

A loan that you get in a lump sum and repay over time is an installment loan. Here are some examples:

What is the difference between a personal loan and an installment loan?

Personal loans are installment loans. Either way, you get a lump sum of money and then pay it back over a few months or years. Personal loans are just one type of installment loan. Others include auto loans, student loans, and mortgages.

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