Installment Loans: What They Are and How to Use Them

6 min read
Installment Loans: What They Are and How to Use Them

If you’ve ever financed a car, mortgaged a house, or taken out a student loan, you’ve likely heard about installment loans. Installment loans are some of the most common types of loans for almost any financial need, and most Americans get one at some point in their lives. Understanding installment loans, how they’re paid, and what personal factors influence your rate will help you navigate the borrowing process efficiently and effectively.

In This Article:

  • What is an Installment Loan?

  • Examples of Installment Loans

  • Main Factors of Installment Loans

  • Installment Loan vs. Revolving Credit

  • The Bottom Line

  • Common FAQ

What Is an Installment Loan?

An installment loan is a type of loan taken out for a fixed amount and repaid over a predetermined schedule over a set period of time––the “installments.” Payments are typically monthly, but they can also be weekly or even quarterly, depending on the loan.

One of the main benefits of installment loans is that most are fixed-rate agreements, meaning the payments remain the same. This can help significantly when it comes to creating and sticking to a budget. But once you've borrowed the principal amount, you must make payments on a specified schedule and cannot borrow additional money on that loan the way you can with a credit card or another revolving line of credit. If you anticipate needing ongoing funds, this can be a drawback.

Examples of Installment Loans

There are many different types of installment loans depending on what you need to finance.

Auto loans

Auto loans are often listed according to how long the loan will take to pay off. For instance, you may hear of 24-month or 36-month car loans. In those cases, the price must be paid in full by the end of the loan agreement.

Traditionally, auto loans were offered at the dealership, but increasingly, individuals are choosing to get auto loans online, at their bank, or through another third-party financial institution.

Home mortgages

Mortgages are installment loans that virtually every homeowner takes out at some point. These home loans require a down payment—anywhere from 3 to 20 percent of the home’s value—with the remainder paid off monthly for the set time period of the loan. Mortgages typically range from 10 to 30 years and can be either fixed or adjustable-rate loans—which refers to whether the interest rate stays the same or changes during the course of the repayment period.

Personal loans

Unlike mortgages and auto loans, personal loans aren’t tied to one specified purpose. It's kind of like borrowing cash from a friend, but on a much larger scale. While personal installment loans still involve borrowing a fixed amount and paying it off for within a set period of time, the loan itself can be used for a number of purposes.

For example, if you have an expensive wedding and honeymoon and find yourself low on funds, applying for a personal loan would allow you to spread the cost over several months or years. Other uses for personal loans include medical bills, home repairs and upgrades, or a large unexpected expense. Because many personal loans are unsecured loans, meaning they aren’t backed by assets, they are considered riskier by lenders and can carry higher interest rates than mortgages or home equity lines of credit.

Student loans

Student loans pay for higher education, and their payment schedule starts 6 to 12 months after graduation. These loans can take a couple of years or decades to pay off, depending on what institution issued the loan, how much was borrowed, and how much it cost. Generally, student loans carry interest rates of 3 to 14 percent but can be refinanced at lower rates after the borrower becomes employed. Student loans can be either federal—meaning they’re provided by the government—or private through an online lender or bank.

Main Factors of an Installment Loan

Understanding the terms of your installment loan offers will ensure you get the right type of loan for your situation.

Loan amount

The first thing to consider in any loan: how much money do you need to borrow? Installment loans tend to be fairly large, so they are paid off over long periods of time. This is especially true if they are tied to a collateral asset such as a house or car via an auto loan or mortgage. Unlike a line of credit, the amount you borrow for an installment loan is fixed, so you’ll want to make sure you borrow enough for your needs.

Interest rate

Interest is, in essence, the cost of your loan. The higher your interest rate, the more money you’ll owe for each dollar borrowed. Keep in mind, the advertised interest rate and annual percentage rates (APR) are different. APR measures the total cost of your loan including fees and interest, as opposed to just the interest. So when you’re deciding between loans, compare the total APR.

Repayment period

Generally, the faster you pay off a loan, the less you’ll pay in interest. But the shorter the repayment period, the larger your monthly installments will be, as you’re paying off the same amount in less time. Be careful to note loan terms, as many installment loans have prepayment penalties if you pay the loan off too early. When considering options, choose the shortest repayment period that you can manage without stress.

Secured versus unsecured

A “secured” or “unsecured” loan type refers to whether a loan is backed by collateral. Securing a loan by tying it to an asset makes it less risky for the lender and allows you to borrow more money, generally with lower interest rates. However, this also means your asset could be seized if you fail to repay on time.

Fixed versus variable

A fixed rate is one that does not change after you start repaying. With a variable rate (or adjustable rate) the interest charged on the outstanding balance fluctuates based on predetermined factors. Though most installment loans are fixed, it’s common to see variable rates with higher-priced amounts, like mortgages. Be careful when evaluating variable interest loans—though they’ll often start with lower interest rates, they can change without reminder or warning to much higher rates after a certain time period has expired.

Credit score

Credit scores and credit history are key factors lenders use in determining the interest rate you will receive on a loan. Though there are installment loan options for individuals with bad credit, you’ll want to check your credit report to make sure your score is accurate before signing up for a loan.

Installment Loan Versus Revolving Credit

In addition to installment loans, revolving credit is one of the most common ways to borrow large sums of money. With revolving credit, your borrowing capacity is flexible, meaning you can continuously use and repay funds as needed. The best example of this is a credit card or a home equity line of credit.

Both loan types have their advantages. Revolving credit lines allow for flexibility for how and when they can be paid off, while installment loans allow you to borrow more money and have a longer period of time to pay back the principal. Keep in mind revolving credit can often carry higher interest rates than installment loans.

The Bottom Line

If you’re considering borrowing money, always consider first how much you need and how long you need it. If you know exactly how much and feel confident in being able to pay back a fixed monthly payment, then installment loans could be an option for you. To find the best installment loans, shop around with multiple lenders, and make sure to consider customer service, reviews, and ease of repayment before committing.

LendingClub’s application only takes two minutes, and you can check your rate for free without impacting your credit score.

Installment Loans FAQ

Still have questions? Some of these commonly asked questions may provide the answer.

How much can I receive in an installment loan?

If you’re buying a house, you can get anywhere from 70 to 95 percent of the home value in a mortgage. For personal loans, you’ll likely receive less money, especially if the loan isn’t backed by an asset. It also helps to consider how much you can pay in monthly payments and how that compares to the amounts offered to you.

Can I refinance my installment loans?

If your income or creditworthiness has improved since opening your installment loan, you may be able to save money by taking out a new loan with a better rate, and then paying off the former loan with the new funds. This is especially true for student loans or debt with a high interest rate. At LendingClub, for example, 3 million members have used a personal loan to pay down their high-interest debt. The best way to tell if you’re eligible for a new personal loan is to get pre-qualified. LendingClub, for example, lets you check your rate and see your loan options in minutes without impacting your credit score.

Is it better to borrow $5,000 through a credit card or personal installment loan?

It depends on your desired flexibility for funds, the offered interest rates, and how quickly you can repay what’s been borrowed. Credit cards generally carry higher interest rates than installment loans; however, they also have no fixed payment schedule and some months can have more or less money due depending on how much you’ve spent. This makes them attractive if you need small, ongoing purchasing power, or are able to pay back the funds quickly. But an installment loan might make sense for larger, defined amounts or if you need more time for repayment.

How long does the loan application process take?

The application process for installment loans takes anywhere from one business day to two weeks, and many auto loans can be approved the same day. When applying, make sure you have all your credit information, income documentation, bank statements, and government IDs ready to show if the lenders ask for it.

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A representative example of payment terms for a Personal Loan is as follows: a borrower receives a loan of $19,584 for a term of 36 months, with an interest rate of 10.29% and a 6.00% origination fee of $1,190 for an APR of 14.60%. In this example, the borrower will receive $18,663 and will make 36 monthly payments of $643. Loan amounts range from $1,000 to $40,000 and loan term lengths range from 24 months to 60 months. Some amounts, rates, and term lengths may be unavailable in certain states.

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