What Is an Installment Loan?
Installment loans are powerful financial tools. They’re often used when people need to fund a purchase that they don’t have the cash for up front. You may even already have one — but you probably call it your mortgage or your auto loan. There are many different kinds of installment loans.
Personal installment loans are a type of loan that provides short-term funding for a range of expenses — everything from covering rent to consolidating debt. They’re typically for a smaller amount than other kinds of installment loans.
So what exactly makes a loan an installment loan? Let’s take a look.
What Is an Installment Loan?
An installment loan is a type of loan that you repay gradually instead of all at once. When you get an installment loan, you’ll receive a lump sum of cash and be given a repayment schedule. Payments will be due at regular intervals — typically weekly, biweekly or monthly. These payments are called “installments.”
The two main things that make a loan an installment loan are:
- Lump-sum funding
- Installment repayment schedule
The main benefit of an installment loan is it allows you to borrow a large sum of money and pay it down in smaller, more manageable pieces over time.
How Does an Installment Loan Work?
All installments loans allow you to borrow a fixed amount of money that you pay back according to an agreed-upon schedule. The terms and length of the loan, however, will be different depending on the lender, the loan amount and what the loan is for.
Say you need to get your car fixed, but you don’t have the cash right now. You apply for an installment loan, get approved and receive the funds. You use the money to fix your car and get back on the road.
When it comes time to begin repayment, you’ll have a series of equal payments due every month, or maybe every two weeks — depending on what schedule works for you. You’ll pay the loan back, along with the accrued interest, in these bite-sized pieces. At the end of the agreed-upon schedule, the loan will be paid off.
What Is Considered an Installment Loan?
Loans that are considered installment loans include:
- Mortgages — A mortgage is a type of loan that is used to purchase or maintain real estate like a house or land. Most mortgages will require a down payment and the installment payments can be spread over 30 years.
- Auto Loan — An auto loan provides money to purchase a car. Repayment can be spread out anywhere from two to eight years. Auto loans often require a down payment.
- Personal Loan — A personal loan lets you borrow money to take care of a wide range of personal needs — from debt consolidation to emergency expenses to large purchases. The terms, conditions and amounts can vary widely depending on your financial situation and the lender.
- Student Loans — Student loans are a type of installment loan used to fund education expenses. They are typically unsecured loans and don’t require any form of down payment or collateral. The repayment period can be stretched up to 20 years.
What Is the Difference Between an Installment Loan and a Line of Credit?
There are a lot of differences between an installment loan and a line of credit — mainly that a line of credit is a form of revolving credit.
But what is revolving credit?
A good example of revolving credit is your credit card. You have a set limit that you can borrow up to, and when you make your payments you’re able to borrow that money again… and again.
This means that unlike an installment loan, there is no set payoff date. Your line of credit will stay available to you until the account is closed.
Here are the key differences between an installment loan and a line of credit.
- Funds are issued up front in one lump sum.
- Once the loan is repaid, the account typically closes.
- Since funds are issued up front, interest and fees are applied to the whole amount.
Lines of Credit
- Provides access to funds up to a certain limit.
- Funds typically become available again once the balance has started to be repaid.
- Interest and fees are only applied to the amount you borrow.
What Is an Unsecured Installment Loan?
An unsecured installment loan doesn’t require collateral, which is an item of value that can be seized by the lender if the customer doesn’t repay the loan. Some loans, like mortgages and auto loans will require collateral, making them secured loans. In these cases the house or the car will serve as the collateral.
Other kinds of installment loans are more often unsecured. This includes things like student loans or personal loans. This means that the lender can’t come after your personal assets if you default, though it will damage your credit score if you don’t pay.
Unsecured loans will have a wide range of terms and conditions depending on your personal credit history, the lender and your financial situation.
How Does an Installment Loan Affect My Credit?
Like most types of loans, an installment loan can either help or hurt your credit. They can help by adding good credit history and expanding your credit mix.
Repayment history is the biggest contributor to your FICO score, so if you have an installment loan and you’re making on-time payments, this can give you a boost. Your credit mix may not count for quite as much, but a good mix of credit types can also improve your score.
On the other hand, missing payments will damage your score. Applying for new credit can also make your score drop a few points — but this is typically recovered quickly and isn’t a big deal if you don’t apply too much.
Using loans and other forms of credit always carries some amount of risk. But according to a study from the American Financial Services Association, installment loans are one of the best ways to build a positive payment history and manage credit.
What Is the Average Fee for an Installment Loan?
There is no average fee for an installment loan because of the diversity of use and variety of lenders and borrowers. The fees, APRs and other terms cover a wide range. This is actually good news — there are installment loans available for almost all types of use and credit profiles.
If you have a good credit score, you’ll be able to secure better rates and terms for an installment loan. But even if your score isn’t where you want it to be, you may still be able to receive funding.