What Is an Installment Loan?

What is an installment loan? You don’t hear the term every day, but chances are you already have one already.

An installment loan provides a lump sum of money that you pay back in equal monthly payments, plus interest. Auto loans, mortgages and student loans are all types of installment loans.

What is an installment loan, and how does it work?

An installment loan is like borrowing money on a payment plan. You get your loan as a lump sum, and you pay back a little bit of what you owe each month. Some installment loans give you cash, like a personal loan. Others go directly toward a big-ticket item, such as a mortgage for a home purchase.

It costs money — in the form of interest and fees — to borrow. Your monthly payments will include interest and most fees. The longer you take to pay off your loan, the more overall interest you’re likely to pay. Once you pay off your loan, the lender will close your account.

Types of installment loans

At a high level, there are two main types of installment loans: secured and unsecured.

Secured installment loans

A secured loan requires collateral. Collateral is a valuable piece of property that the lender can take if you don’t repay what you borrowed. Secured loans can be risky, but for some, the risk is worth it. Secured loans are generally easier to qualify for and tend to carry lower rates.

Some common secured installment loans include:

• Auto loans: Auto loans are usually secured, with the car being financed as collateral. Some lenders give you the loan, which you will then use to pay the dealer or seller. Others pay the dealer or seller directly.
• Mortgages: You use a mortgage to buy a home, with your home as collateral. The funds from your mortgage could go to the seller, the seller’s mortgage company or a combination of both. It depends on whether the seller owns the house outright or is still making payments.
• Pawn shop loans: Pawn shop loans are secured by a valuable personal item, such as jewelry. These are short-term, high-cost loans. You may have to pay back your loan in full within 30 to 60 days.

Unsecured installment loans

An unsecured loan doesn’t require collateral, so it carries less risk for you, the borrower. Instead, that risk shifts to the lender.

Unsecured loans can be harder to qualify for and have higher rates than secured loans. At the same time, you won’t lose your property if you stop paying (but your credit score will still take a huge hit).

Some common unsecured installment loans include:

• Personal loans: Personal loans can be secured or unsecured, but unsecured is more common. Personal loans provide a lump sum of cash that you can use for almost anything.
• Student loans: Student loans are unsecured and, in the case of federal student loans, get sent directly to the school. Then, leftover funds will be sent to you to use for school-related expenses.
• Buy now, pay later loans: A buy now, pay later (BNPL) app lets you break up retail purchases into payments. BNPL apps are easy to use, which can lead to overspending.
• Payday loans: Payday loans are small, high-cost installment loans that allow you to “borrow” from your paycheck early. Your loan payment (plus interest) is typically due at your next pay day.

Avoid predatory lending

Payday loans and pawn shop loans are a form of predatory lending. Most financial experts agree that a loan is predatory if it has an annual percentage rate (APR) higher than 36%. According to the Consumer Financial Protection Bureau (CFPB), the typical APR on a payday loan is around 400%. APRs for pawn shop loans vary, but they can reach the triple digits, too.

Payday loans and pawn shop loans may be tempting — they don’t require a credit check. Still, avoid them. Many people end up worse off after taking a payday or pawn shop loan.

Pros and cons of installment loans

Installment loans can help you reach some of life’s most exciting milestones, such as buying a car. But there is no one-size-fits-all approach to personal finance. Reviewing pros and cons can help you figure out if an installment loan is right for you.

Pros

 Fixed rates. Most (but not all) installment loans have fixed interest rates. Fixed rates can provide peace of mind since they won’t fluctuate (especially important in a volatile economy).

 Lump sum of cash. A personal installment loan gives you cash up front, so this type of loan can be a lifesaver for unexpected expenses.

 Large loan amounts. Without an installment loan, buying a house or car would be impossible for many.

Cons

 Not free. Loans cost money, thanks to interest and fees.

 Can’t borrow from the same loan more than once. If your installment loan doesn’t cover what you need, you’ll have to take out another loan to get more money.

 Can lock you into a cycle of debt. Some installment loans, like payday loans and BNPL loans, are easy to get. It takes discipline to avoid overborrowing.

Do installment loans hurt your credit?

Installment loans can affect your credit score in a few ways.

Most lenders offer prequalification, a process that allows you to check rates without damaging your score. When you formally apply, the lender will likely run a hard credit pull, which will drop your score by a few points.

Rate shopping tip

If you get your loan shopping done within 14 days, only one hard credit pull will count against you. Take advantage of this window to avoid taking too many dings to your credit score.

After you’ve gotten your loan, you’ll probably see your credit score go up as long as you make your payments on time. And if this is your only installment loan, you could see a positive bump because you’ve diversified your credit mix.

If you make late payments (or stop paying altogether), your credit score will go down, likely dramatically. Your score might also dip when you pay off your loan. One less loan means a less diversified credit mix, and closing your loan could affect the age of your credit history.

An installment loan could improve your credit score, or it could hurt it. But a history of on-time payments on a loan (or credit card) can make you more creditworthy in the eyes of a lender.

Can you get an installment loan with bad credit?

It’s possible to get an installment loan with bad credit, but it depends on the lender and the loan you’re requesting. If you do qualify with bad credit, you might find rates unaffordable.

To improve your chances of being approved, you could:

• Offer collateral. Secured loans are typically easier to get, since the lender can take your collateral if you don’t pay back your loan.
• Add a cosigner. A cosigner or co-borrower is someone who you add to your loan as a sort of safety net for the lender. They are equally responsible for the loan, so late payments will also impact their credit score.
• Review your credit report. You can order your credit report for free once a week at AnnualCreditReport.com. Check your report, and if you see an error, dispute it. Successfully disputing errors may take some time but can increase your score.

You could turn to a no-credit-check loan as a last resort, but know that you could face triple-digit APRs. Before you get shopping, check your credit score for free with LendingTree Spring to see where you stand.

Where to get a personal installment loan

Banks

You might get a good deal on a personal installment loan from your current bank. Some banks give an APR discount to members who both bank and borrow. Bank loans usually require good to excellent credit.

Also know that lenders tend to tighten their books when the economy is volatile. As a result, many banks have backed out of the personal loan business. For instance, you can’t get a personal installment loan from Bank of America, Chase or Capital One.

Credit unions

Generally, credit union loans have some of the cheapest rates. That’s because federal law caps their APRs to 18.00%. But you must be a member to get a loan, and some credit unions are hard to join due to strict membership requirements.

Once you are a member, your credit union might be willing to work with you if you have less-than-perfect credit. Credit unions are member owned and not-for-profit, and some have a mission to help members access financial tools such as loans.

Online lenders

Online loans can be convenient and may be easier to qualify for, too. If you have bad credit, though, prepare for high interest and in some cases, more fees. Still, the expense may be worth it if you can’t get a loan elsewhere.

On the plus side, those with good credit or better might get similarly low rates as those on bank and credit union loans.

How to compare installment loans

Not all installment loans work the same, but some definitions apply across the board. When you’re comparing loans, pay attention to the metrics below.

• APR: Your APR measures the total cost of a loan, including interest and fees. The higher your APR, the more expensive your loan. Some lenders require a credit score of 700 or higher to get the lowest rates (or to qualify at all).
• Repayment terms: Your repayment term is how long you have to pay what you borrowed. Usually, the longer a repayment term, the more overall interest you’ll pay. APRs on longer loan terms also tend to be higher. However, a long term can result in a lower monthly payment, since you have more time to spread your balance across.
• Fees: Fees have more variation. Auto loans come with dealer fees. Mortgages have closing costs. Origination fees can be common on personal loans. Know what fees apply before borrowing.
• Loan amounts: An installment loan provides a lump sum, so be sure your loan is big enough for what you need. The higher your credit score, the more money lenders may be willing to loan you.

Installment loan alternatives

Installment loans won’t work for everyone. If you need to borrow on a continual basis, you might be better off with a form of revolving debt. You can borrow from revolving debt over and over, up to a certain limit. Paying back what you borrowed opens up more credit that you can borrow from again.

 Credit card

A credit card can make sense for everyday purchases, especially if you can earn cash back rewards or airline miles. Credit cards usually have higher APRs than personal installment loans. However, as long as you pay your balance in full before the due date, you won’t be charged interest.

 Personal line of credit

A personal line of credit (PLOC) is like a credit card, but you can only borrow from it for a certain period of time. This is called the draw period. Once your draw period is over, you’ll pay back what you borrowed (called the repayment period). You’ll also make minimum monthly payments during your draw period.

Compared to cards, PLOCs are better suited for large but infrequent purchases — your lender might charge a fee every time you draw.

 Home equity line of credit

A home equity line of credit (HELOC) is like a PLOC, but it uses your home as collateral. HELOCs are risky — if you default, your lender can foreclose on your house. Because HELOCs are secured loans, they usually have lower rates than unsecured PLOCs and credit cards.