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What Is an Installment Loan?
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Installment loans are a form of financing that allows you to repay a lender in small portions over a period of time. They can make it easier for consumers to afford big-ticket items, whether that be a new home or vehicle.
Here’s how installment loans work and where you can find them.
What is an installment loan?
An installment loan is a generic term that can be used to describe most types of loans. These can include personal loans, auto loans, mortgages and student loans.
Typically, these loans are offered in lump sums and borrowers repay them over a set period in small installments. The interest rates and monthly payments are commonly fixed, so the borrower pays the same amount each month.
Other types of credit, such as credit cards, come with a revolving line of credit as well as variable interest rates, so the amount borrowers pay each month varies.
How do installment loans work?
Like many forms of credit, approval for an installment loan is typically judged based on your creditworthiness, or how likely you are to repay the loan. Loan approval commonly relies on the following factors:
- Credit score
- Payment history
- Credit utilization ratio
- Debt-to-income ratio
After you’re approved for an installment loan, you’ll either receive a lump sum (in the case of a personal loan) or the item you purchased (in the case of a mortgage or an auto loan).
Installment loans can be either secured or unsecured loans. Secured loans are backed by collateral. With auto loans, for instance, the vehicle you purchased serves as the collateral. If you are unable to repay your debt, your lender can legally seize the asset securing the loan.
Unsecured loans do not require collateral. If you default on an unsecured personal loan, the lender cannot seize your vehicle or foreclose on your home. However, there are other consequences if an unsecured personal loan isn’t repaid.
Types of installment loans
Personal loans are loans that are provided to borrowers in lump sums. They typically come with fixed interest rates and loan-length terms, unlike credit cards.
These loans are a popular choice among consumers since they offer a lot of flexibility in how they can be used, unlike other types of installment loans. Personal loans can be used toward a wide variety of needs, including debt consolidation, credit card refinancing or medical bills.
Buy now, pay later loans
Buy now, pay later (BNPL) loans are a form of financing that many retailers offer. It allows customers to purchase items without paying the entire balance upfront.
BNPL financing typically comes in three forms:
- Pay in 4: This is by far the most common form of BNPL loans. Your balance is split into four payments that must be paid off within six weeks. You make one payment immediately and then every two weeks until the loan is entirely paid off. This type of BNPL loan usually does not come with interest.
- Pay in 30 days: Instead of paying in installments or up front, a pay-in-30-days loan allows you to try out an item before paying. As the name implies, however, if you want to keep the item, you’ll need to pay for it within 30 days.
- Monthly payments: This type of payment plan typically comes with interest. Similar to a personal loan, these payment plans allow you to make monthly installment payments on larger purchases.
A mortgage loan is an agreement between a homebuyer and a lender. You provide a down payment, and the lender loans the rest of the funds necessary to purchase the home. You’ll then repay the loan over a long period, commonly 15 or 30 years, plus interest and fees.
Keep in mind that mortgages are secured loans, so if you don’t keep up with payments, your lender can foreclose on your home and sell it to recoup its losses.
If you’re in the market for a new vehicle, an auto loan can help you afford it. Auto loans are typically repaid over two to seven years, and your interest rate will be determined by your creditworthiness, the size of your loan, the length of your loan and the value of your vehicle.
Similar to other types of installment loans, your lender will provide the money up front so you can purchase the vehicle. You’ll then make monthly installments to repay the balance plus interest.
Like mortgages, auto loans are secured loans. If you’re unable to repay the loan, your lender can legally repossess your vehicle.
Student loans are a type of installment loan that are used to fund post-secondary education. These types of loans can go toward tuition, room and board, books, transportation and any other costs related to your education.
These loans are unsecured and can come with variable or fixed interest rates. Student loans also typically come with various types of payment plans, such as making payments while in school or deferment.
Pros and cons of installment loans
Installment loans come in many different shapes and sizes, but that doesn’t mean they’re a good fit for everyone. Here are a few benefits and drawbacks to consider before signing on the dotted line for an installment loan.
Fixed monthly payments
May be able to refinance
May improve credit score
May have to pay interest and fees
May be charged prepayment penalties
Only provided a fixed amount
Fixed monthly payments: Because installment loans typically come with fixed interest rates — meaning your APR will remain the same throughout the life of the loan — consumers can expect to pay the same amount each month. This can make it easier to create and stick to a budget.
May be able to refinance: If your credit score wasn’t great when you received your installment loan, or if interest rates have come down, you may be able to refinance your debt.
May improve credit score: As long as you’re making on-time payments to your installment loan, you may see your credit score gradually increase as you continue to pay off your loan. This can make it easier to qualify for more credit opportunities later on.
May have to pay interest and fees: Unfortunately, many types of installment loans come with fees and interest rates. For instance, you may have to pay an origination fee for a personal loan, typically 1% to 8%, which may be taken out of the total balance of your loan. If you have high interest rates and fees, repaying your installment loan can be challenging.
May be charged prepayment penalty: While paying off your debt early can be a positive thing, some loans may come with prepayment penalties. As the name suggests, this fee is sometimes applied for paying back your loan ahead of schedule, and it is typically associated with auto loans, business loans and mortgages. Prepayment penalties are a way for lenders to recoup the interest payments they lose out on when you pay your loan off early.
Only provided a fixed amount: Installment loans may not be a good fit for you if you’re unsure of how much money you need. Because the funds are typically provided in the form of a single lump sum, you may have to seek other forms of credit if you find yourself needing more money. For instance, if you borrow a $50,000 home improvement loan but later find that you need an additional $10,000, you will have to apply for another loan or use a credit card.
Installment loans to avoid
Installment loans aren’t always good news for borrowers. In some cases, even with reputable lenders, interest rates and fees are too high to reasonably afford. This can lead to consumers defaulting on their loans because they’re unable to keep up with payments.
It is wise to avoid predatory lending practices, including payday loans. These types of installment loans may seem tempting because you can get your funds immediately and they don’t come with credit checks. However, payday loans can come with interest rates as high as 400%, and borrowers often become trapped in a cycle of debt trying to repay these loans.
How installment loans can impact your credit score
Your credit score is calculated based on the activity on your credit report. Specifically, the following details are evaluated:
- Payment history
- Credit utilization ratio
- Types of credit
- New credit
- Credit history length
If you borrow an installment loan, it will show up on your credit report as a new credit account and perhaps even a new type of credit if you’ve never taken out an installment loan before.
With any new credit account, you may be subject to a hard credit inquiry, which can temporarily pull your credit score down by a small amount. However, if you make your payments in full and on time, your credit score can benefit.
Where to find installment loans
Whether you’re purchasing a car or consolidating debt with a personal loan, installment loans can be found with a variety of lenders, including banks, credit unions and online lenders.
Installment loan terms can vary widely depending on the type of loan and lender. It pays to shop around and prequalify with multiple lenders. If you can find a lender that offers a better interest rate or other terms, you could save a significant amount of money over the life of the loan.
You can physically go to your local banks and credit unions to shop for installment loans, or you can consider online lenders.
In some instances, online lenders may have better rates because they don’t have to account for the same overhead costs that brick-and-mortar lenders do.
The loan application process will depend on the type of loan you’re seeking. However, no matter what kind of loan you’re shopping for, it’s important to compare multiple lenders before signing on the dotted line to ensure you’re getting the best deal for you. You may receive up to five loan offers by filling out a form at LendingTree’s online marketplace.
Installment loans for bad credit
If your credit history is thin or your credit score could use some work, some lenders may be willing to work with you. Keep in mind that they may charge you higher interest rates, as lower rates are typically reserved for those with excellent credit.
Here are a few types of lenders that are willing to work with consumers with bad credit: