What Is an Installment Loan?
An installment loan lets you borrow a set amount that you repay with interest over a period of months or years.
An installment loan is a common type of loan that’s used to buy a car, house or other large 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 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 payments — or installments — over a period of time, usually months or years. Installment loans can be secured with collateral, like a car, or unsecured.
Installment loans work differently than 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 that require full repayment from your next paycheck.
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Examples of installment loans
Personal loans are installment loans you can use for almost any reason. Available loan amounts range from $1,000 to $100,000, and repayment terms are typically two to seven years. Rates are from 6% to 36%. Use an installment loan calculator to see how the loan’s rate and repayment term affect the monthly payment.
A lender decides whether you qualify for a personal loan and at what rate using information like your credit history and score, income and other outstanding debts.
Unsecured personal loans are more common than secured personal loans, but some lenders let borrowers use a savings or investment account or a vehicle as collateral for the loan to potentially qualify for a lower rate.
With a mortgage, you borrow the value of the house and agree to repay it with interest in monthly increments, typically over 15 or 30 years.
In this case, the installment loan is secured by the home, and after too many missed payments, you risk losing it.
A home equity loan — which is a second mortgage you might take to pay for home improvements — is also an installment loan.
An auto loan is another example of a secured installment loan. You borrow the cost of the vehicle and make monthly payments, plus interest, typically over two to five years. If you miss payments, the lender can repossess your car.
Student loans are installment loans because you pay them back in regular payments over time. They can have fixed or variable rates, though, and often include a period after you’ve borrowed the money when interest accumulates but monthly payments haven’t kicked in.
Buy now, pay later
The at-checkout financing offered through “buy now, pay later” companies is technically an installment loan. BNPL lets you break a purchase into equal, often bi-weekly payments. For example, if you split a $200 purchase into four smaller payments, you’d repay the loan in $50 installments.
How installment loans affect your credit
Applying for an installment loan often requires a hard credit check, which can temporarily lower your credit score a few points. Beyond that, installment loans can strengthen your credit if you make consistent, 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 makes up 35% of your FICO score, and on-time installment loan payments help build that history.
The consequences for missed or late payments can be severe. A payment that’s 30 days or more late can knock up to 100 points off your credit score. Most lenders have the option to set up automatic payments, which removes the pressure of remembering to pay.
How to get an installment loan
- Compare. Lenders use different methods for assessing your loan application and assigning your rate, so it pays to compare installment loans from multiple lenders. Also consider other forms of financing, like low-interest credit cards or lines of credit, especially for big expenses.
- Pre-qualify. Getting pre-qualified for a personal loan or preapproved for a mortgage lets you see potential loan amounts, rates and payments without affecting your credit score. You can then assess how the payments impact your budget.
- Boost your application. Before you apply, consider a joint or co-signed loan or secure an unsecured loan with collateral. These options may help you qualify or get a lower rate or higher loan amount. Just know there are consequences if you’re unable to repay the loan: your co-signer will be on the hook, or the collateral could be taken.
- Apply. Installment loans are offered 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, like bank account transactions, employment, education and existing debts. Credit unions and online lenders may work with bad-credit borrowers, 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 all other fees), and personal finance experts say 36% APR is the maximum rate for a loan to be affordable.
But you’ll find some installment loans with rates of 100% or higher. Lenders that offer high-interest installment loans may not review your credit and ability to repay, and they don’t always report on-time payments to the credit bureaus. These are red flags that signal the loan is at best too expensive and at worst predatory.