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.
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An installment loan is a lump sum of money that you borrow and repay in regular equal payments — or installments — over a period of time, usually months or years.
An installment loan is a common type of loan that’s used to pay for a car, house or other large purchase. You may even have an installment loan that goes by another name, like a mortgage.
How installment loans work
Installment loans can be secured with collateral, like a car, or unsecured. An unsecured loan isn’t backed by collateral that a creditor can seize if you miss payments, so approval is based primarily on your creditworthiness.
Installment loans work differently than revolving credit, which you get with a credit card or home equity line of credit. Revolving credit lets you borrow up to a credit limit, repay that amount, then borrow again if necessary. With an installment loan, you borrow the funds all at once, and you can’t get more money without applying for a new loan.
Types of installment loans
Personal 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 and total interest costs.
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 account or vehicle as collateral for the loan to qualify for a lower rate.
» MORE: Check personal loan rates
Mortgages
With a mortgage, you borrow the value of the house, minus your down payment, and agree to repay the loan with interest in monthly increments. Mortgages are typically repaid over 15 or 30 years.
In this case, the installment loan is secured by the home. 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.
» MORE: What is a mortgage?
Auto loans
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 seven years. If you miss payments, the lender can repossess your car.
Student loans
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 type of at-checkout financing that “buy now, pay later” companies offer 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.
» MORE: What is buy now, pay later?
Example of an installment loan
Suppose you need to borrow $10,000, so you apply for an unsecured personal loan. You’re approved for a loan with a 12% annual percentage rate (APR) and a 60-month term.
Your monthly payment will be $222.44, which you’ll repay in 60 equal installments. Overall, you’ll repay the $10,000 you borrowed plus $3,346.44 worth of interest over the life of the loan.
How an installment loan affects your credit
Applying for an installment loan often requires a hard credit check, which can temporarily lower your credit score by a few points. Getting an installment loan may also cause your score to drop slightly if you lower the average age of your accounts. Beyond that, installment loans can strengthen your credit if you make consistent, on-time payments.
Reputable lenders report on-time payments to 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 you build credit 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 allow borrowers to set up automatic payments, which removes the pressure of remembering to pay.
One benefit of installment loans is that they don’t affect your credit utilization ratio, which is the percentage of open revolving credit you’re using. A lower credit utilization is best for your credit score; experts often recommend keeping your utilization below 30%. If you use an installment loan to consolidate credit card debt, your score may improve since you’ll lower your credit utilization.
Your credit score may also improve slightly if you take out an installment loan and you only have revolving credit accounts, like credit cards. Having a diversified mix of credit accounts is generally good for your credit score.
Pros and cons of installment loans
Installment loans can make large purchases more manageable, but it’s important to weigh the pros and cons alongside other financing options to choose the right one for your plans.
Pay off a large purchase over time.
Fixed-rate loans have predictable payments.
On-time payments build your credit.
You may be able to refinance for a better interest rate or loan term.
May improve credit if the loan is used for debt consolidation.
Once you borrow, you can’t easily borrow more.
Interest rates may be high, especially if your credit score is low.
Missed payments can hurt your credit.
Repayment terms can be long, leading to high interest costs.
How to get an installment loan
Check your credit. Borrowers with good or excellent credit (scores in the mid-600s or higher) are more likely to qualify for installment loans and get lower interest rates. Check your credit report and dispute any errors that may be bringing your score down. Work on building credit if you have time before applying for a loan.
Compare. Lenders use different methods to assess your loan application and assign 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 or get preapproved. Get pre-qualified for a personal or student loan or preapproved for a mortgage or auto loan to see your potential loan amount, rate and monthly payment. This will help you assess how the payments would affect your budget. Pre-qualifying may not affect your credit score, but preapproval may require a hard credit check that causes your score to temporarily dip.
Boost your application. If you’re having trouble qualifying for a loan with a low APR, consider a joint or co-signed loan. You could also ask about whether you can secure an unsecured loan with collateral. These options may help you qualify or get a lower rate. Just know there are consequences if you're unable to repay the loan: Your co-signer will be on the hook, or your collateral could be taken.
Apply. When you formally apply, the lender will do a hard credit check if they haven't yet. The time required to apply and receive funds varies by loan type and lender.
What to know about high-interest installment loans
Lenders must disclose a loan’s annual percentage rate (interest rate plus all other fees), and personal finance experts say 36% is the maximum APR an affordable unsecured loan can have. But some lenders offer 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 or, at worst, predatory.
Note that some high-interest loans, like payday loans, usually aren’t installment loans. Payday loans have low borrowing limits (often $500 or less) and an average APR of 391%. These loans usually require full repayment within two weeks, whereas you repay an installment loan over several months or years.
Getting an installment loan with bad credit
Borrowers with thin or imperfect credit profiles may still be able to get an installment loan with fair or bad credit (a credit score below the mid-600s).
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 or excellent credit.
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